Baidu, Inc. (NASDAQ:BIDU$Baidu(BIDU)$) is in a prime position to become a dominant player in the artificial intelligence market and the growing digital advertising market in China. The market has punished the company's stock since its peak marketvalue at $100 billion. Nonetheless, BIDU has produced outstanding results, with TTM revenues of $17.4 billion, operating cash flow of $3.2 billion, and free cash flow of $1.7 billion.
Due to the combination of strong fundamentals and future growth opportunities, I consider Baidu, Inc. a buy. Let´s take a look at the business.
Business Overview:
Baidu, Inc., also known as the "Google from China," is a Chinese technology company that specializes in Internet-related services and products, including AI and cloud-based services. BIDU has a mobile ecosystem that provides a platform for users to consume information, interact and engage with other users, and transact with merchants through their flagshipapp, the Baidu App.
As per 3Q-2022, the Baidu App has a user base of634 millionmonthly active users. Further to this, BIDU is the leading search engine in China, a country with over1.4 billion people. The company's core business “Baidu Core” is based on AI, particularly on the Baidu Core, which provides search-based, feed-based, and other online marketing services, generating over 75% of total revenues. BIDU also offers cloud services, which is a segment that is rapidly growing. Currently, this places the company as the fourth-largest cloud computing business player in China. Finally, BIDU operates “iQIYI” an innovative market-leading online entertainment service in China which features a variety of premium video content, in particular iQIYI dramas and shows and generates approx. 25% of total revenues.
Financial Overview:
Baidu Financial Highlights(Seeking Alpha & Company´s Annual Report)
As per revenues, cash flow from operations, and market valuation, BIDU is still relatively small compared to other big Chinese technology companies. With TTM revenues of $17.4 billion, operating cash flow of $3.2 billion, and current market valuation of $46.1 billion, BIDU still has a long runway of growth ahead. The company generates revenues mainly through two segments. Baidu Core amounts to over 75% of revenues. Within the core segment, Baidu Cloud has demonstrated substantial growth, generating $2.4 billion in revenues in 2021. This represents a year-over-year increase of 64% in revenues from 2020 to 2021.
The cloud computing segment is a crucial aspect of the company's portfolio as it plays a significant role in diversifying the BIDU revenue streams, which have historically been heavily dependent on digital advertising revenues. Further to this, BIDU also operates iQIYI which competes with Tencent (OTCPK:TCEHY) Video for users and advertising customers, generating about 25% of total revenues. This segment is growing at low single digits, however it provides a diversified stream of revenues to the company.
Management invests aggressively in the company’s capabilities, with almost 20% of revenues spent on research and development. This helps BIDU enhance its search engine, artificial intelligence, and cloud computing capabilities. Returns on investment have been substantial, since, as mentioned, BIDU has become the fourth-largest cloud computing business player in China.
The company has strong fundamentals bolstered by its high cash levels at $24.4 billion. This positions the company with a net cash position. BIDU has generated a free cash flow of $1.7 billion during the previous twelve months, which gives the company enough capital to fund share buybacks or further invest in innovation.
Shareholder Returns:
On December 2020, the Board of Directors of BIDU approved an expansion of the share repurchase program from $3 billion to $4.5 billion. Subsequently, the company has been consistently executing on this program, repurchasing shares at an annual rate of $1 billion, indicating management's belief that the stock is currently undervalued. This perspective is further reinforced by the fact that the BIDU share price has experienced a significant decline, falling 60% from its all-time highs. As of the third quarter of 2022, the cumulative repurchase of shares under this program stood at $3.2 billion. Given that the company does not currently pay dividends, it is possible that shareholders may see an enhancement in the share buyback program in the near future.
Baidu Shareholder Returns(Seeking Alpha & Company Annual Report)
Key areas of focus for BIDU future growth
A key area for Baidu, Inc.'s future growth is enhancing its AI-powered technology to offer targeted and effective advertising solutions for businesses. BIDU has a strong presence in China's digital advertising market, and leveraging capabilities will position the company to take advantage of the growing digital advertising spend in China, providing a solid foundation for future revenue growth. For reference, in China over 81% of total advertising media go to the digital advertising market. This is why it is expected this market will grow to$190 billionby 2026.
China Digital Ad Spending(eMarketer)
As previously mentioned, BIDU is also a dominant player in China´s cloud computing market, currently holding the fourth largest market share behind Alibaba (BABA), Tencent, and Huawei. The company offers a full suite of cloud services and solutions, including IaaS (infrastructure as a service), PaaS (platform as a service) and SaaS (software as a service). We can expect management to continue investing in and enhancing the company's cloud capabilities, as this market is expected to grow in China alone to$84 billionby 2025 and globally to$1.2 trillionby 2027.
China Cloud Market Forecast (Canalys)
The final key area for growth is artificial intelligence. BIDU is a leading AI company, with the company investing in its AI capabilities since 2010. The company has a full AI stack that includes AI chips, deep learning framework, core AI capabilities, and an open AI platform. The open AI platform has a strong developer and business community, which in turn helps to improve their AI capabilities and make them more attractive to the market. As of December 2021, the PaddlePaddle developer community stood at 4 million and served 157,000 businesses. The usage of the platform creates a network effect that contributes to the company's growth in the AI market. BIDU is well-positioned to take advantage of the global AI market, which is expected to grow over$400 billionby 2028.
I will not discuss the intelligent driving and Apollo Robotaxi opportunities in this article, as I believe these initiatives are still a long way from really having an impact on the company´s financials.
Valuation:
Baidu, Inc. has experienced a significant decline in market valuation of over 70%, from its peak at $100 billion on Feb. 2021 to its trough at $26 billion in Nov. 2022. The current market valuation of the company is $46.1 billion, which represents a multiple slightly above 14x cash flow from operations and 2.5x sales.
Despite this decline in value, the company's long-term growth prospects remain robust, given its potential to capture a significant share of the growing cloud computing, artificial intelligence, and digital advertising markets. It is worth noting that the digital advertising and cloud computing markets in China are projected to attain a combined valuation of approximately $275 billion by 2026. This presents a significant opportunity for BIDU, as these markets continue to grow and offer potential for the company's expansion.
For the valuation of the company, I have used the market multiple method, using future forecasted cash flow from operations to a 17x multiple.
Baidu Forecast(Author Estimates & Seeking Alpha Data)
I obtained the analysts' revenues forecast from Seeking Alpha data and have applied an operating cash flow margin of 16%, which is below the previous 3 years operating cash flow margin at 26%, 22%, and 16.1%, respectively. Given these assumptions, I have applied a multiple of 17x. This multiple is below the company historical price to earnings ratio, which historically has beenabove 17x. Using this method, I have arrived at a market valuation for BIDU of $72 billion by 2026.
Risks:
Dependance on advertising Revenues:BIDU generates a significant portion of its revenues from advertising. This is why it is important for BIDU to diversify revenues streams, as its financial performance could be impacted by changes in the advertising market. The management team of the company has been actively implementing strategies to diversify revenue streams, including a focus on the rapidly expanding market of cloud computing.
Semiconductor Restriction:It is well known that advanced semiconductors play a crucial role in powering a wide range of potentially transformative technologies. The restrictions imposed on China by the USA have the potential to limit China's firms' abilities to build advanced data centers and deploy artificial intelligence. Advance semiconductors are also essential for improving supercomputing and artificial intelligence capabilities. The biggest impact of these restrictions will be felt by China's technology firms, as the cost of AI is expected to be very power-intensive, making it expensive to implement.
Bottom Line
In conclusion, Baidu, Inc. is a dominant player in China's digital advertising and cloud computing markets. Management is expected to continue investing in and enhancing the company's AI and cloud capabilities, as these markets are expected to continue growing. BIDU also has strong financial fundamentals, including high cash levels at $24.4 billion, a net cash position, and the ability to constantly generate free cash flows. Overall, Baidu, Inc. is well-positioned for growth in the digital advertising, cloud computing, and artificial intelligence markets, giving investors the potential for solid returns.
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