To The Moon

Over the course of the second quarter (Q2) of the calendar year, a number of institutional investors – with Scion Asset Management run by Michael Burry of "The Big Short" fame finding particular mention in the media – loaded up on shares of China search giant Baidu, Inc ( $Baidu(BIDU)$ in the U.S.; $BIDU-SW(09888)$ in HK) as it floundered. The stock has notably not been doing well over the course of the Year Till Date (YTD) and its Q2 earnings were decidedly mixed: while revenue did drop on a quarter-on-quarter basis by 0.4%, it delivered ¥33.93 billion ($4.67 billion) as opposed to analysts' average estimate of ¥33.55 billion. 

There are likely several factors behind the uptick in share "buy-ins", most of which is related to specific trends in key line items.

Trend Drilldown

As of the first half (H1) of the company's Fiscal Year (FY), trends in revenue indicate that it will underperform the previous FY by about the same rate as the latter had outperformed:

However, in terms of net income, trends indicate that the company's bottom line net income will close out the year with a net 4% and 6% increase in net income and earnings per American Depository Share ("ADS", which equals eight shares) respectively. 

The company's expenditures in infrastructure are cyclical and interesting. For instance, while net revenues were up by a whopping 19% in 2021 relative to the previous, both net income and earnings per ADS were down by over 50% as the company spent and expanded infrastructure and capabilities. When said capabilities mature, the effect on the bottom line is electric: a mere 6% increase in revenue in FY 2023 translated to a massive triple-digit percentage increase in net income and earnings per ADS. 

To many investors in the West, Baidu is perhaps best known/described as China's "Google" in that its mainstay is ostensibly its search engine. Unlike in the Western Hemisphere – where Google reigns supreme with a 90%-plus market share – China's search space seems a little more fragmented: 

Among China's homegrown search engine options outside of Baidu, Tencent's ($TENCENT(00700)$) Haosou – which is optimized to crawl through Chinese social media, particularly the near-ubiquitous WeChat (also by Tencent) – has been the only domestic competitor that is estimated to have occasionally shown signs of sustained periodic uptrends while the mobile-only search engine Sogou – developed by Alibaba ($Alibaba(BABA)$; $BIDU-SW(09888)$) – is steadily flattening away from consequence. 

While Baidu is estimated to have come close to breaking through to the 90%-plus market share towards the end of 2021, this is estimated to have declined in favour of a Western competitor: Microsoft's Bing. 

Within the “Great Firewall of China”, citizens' curiosity is a matter of intense scrutiny that search engines must necessarily tread lightly through. In other words, a proactive and "censorious" paradigm works out best in terms of managing regulatory risk. Microsoft has long worked on building out where the likes of Google have largely abandoned efforts to make inroads by building out a censorship framework that U.S. lawmakers have contended is more rigorous than domestic engines. Microsoft, however, maintains that the Chinese version of Bing is "the least censored search engine” in the country.

However, there are numerous workarounds when curiosity isn't in certain matters and is instead (for example) of a more commercial nature. Herein, the company has traditionally shone. In its "Core" segment, the company's online marketing division is the workhorse of the company primarily via the Baidu App while cloud services – much like Google Cloud or Amazon's AWS – has been a division that has been nurtured cyclically and led to progressively stronger payoffs. Within this division also lies its driverless taxi venture "Apollo Go", which (as of Q2 2024) offers 100% fully driverless ride-hailing services in practically the entirety of Wuhan, a Chinese city of some renown even among those not entirely proficient in China's geography. A relatively recent entrant to the company's ranks has been ERNIE, a chatbot in the vein of ChatGPT, which is being made available to a wide swathe of corporate clients at increasingly higher cost-effective pricing bands. 

Like many tech giants, the company also owns iQIYI, a long-from video platform in the vein of Amazon Prime, Apple TV and so many others. 

Segment-wise trends show some interesting trends: 

Note: Division-wise line items are very limited in quarterly releases, unlike in annual reports. 

While both "Core" and "iQIYI" are trending below par in terms of revenue as of H1 2024, "Core" shows a positive uptrend in net income as the company optimizes utilization of infrastructure and capabilities. Content production and distribution is often a gruesome business with high capital usage and uncertain payoffs. From FY 2020 till 2022, iQIYI's was no different and delivered net losses on the company's bottom line. This changed in FY 2023 when net income went positive with $275 million. In fact, throughout FY 2020 till then, net losses steadily declined. As of now, iQIYI's net income trend - predominantly driven by subscriptions - remains positive but is trending towards a little under 75% of that recorded in the previous FY. 

Market Trends and Conclusion

Over the course of the year through the date of the earnings release (i.e. the 22nd of August), both the company's ADS and Hong Kong-listed stock have had a strongly-correlated downtrend with the ADS being slightly less of an underperformer with a loss of 31.32%

Traded volumes for the Hong Kong stock on average have been 2.78 times that seen in the ADS for the same period. However, ADS traded volumes spike much higher than the stock's on moments when prices trend upwards. On the day before the earnings release, ADS volumes spiked upwards while Hong Kong traded volumes dipped. 

While it is indeed true that online marketing driven by the search engine is flagging due to economic headwinds cooling the average Chinese consumer's appetite for consumption, sophisticated investors are likely sensing one critical feature: the company's consumer mix is increasingly "corporate". 

The launch of ERNIE 4.0 Turbo in June 2024 that is designed to run faster, at lower cost and offering superior capabilities for typical use cases as compared to ERNIE 4.0 as well a "native" AI Cloud developer community numbering at 14.7 million have fostered a stack of applications across the spectrum of corporate interfaces within Baidu's ecosystem. In Q2 2024, 51% of online marketing revenue was derived from "Managed Page", wherein clients can build an account and use Baidu ecosystem apps and tools to engage with users without maintaining their own website and paying for software, server and bandwidth costs. 

Simultaneously, the company also reports that it's working on renovating its search algorithms which it concedes will be a substantial cost in the short term but believes will lead to greater long-term success. Given the complexity of the task the likes of Baidu is into, this belief is an interesting proposition for some investors. While the short-term top-line trends (i.e., in revenue) won't endear the stock to many retail investors, its ongoing consumer mix transformation has been piquing the interest of the long-term institutional investors who consider the current valuation to be ideal for "buying the dip" as part of a mid- to long-term strategy.  

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Note: Investors with access to European exchanges can consider Exchange-Traded Products to boost gains on short-term stock trajectories. The “+3x Long Baidu ETP” (LSE ticker: BID3) gives a 3X daily-rebalanced exposure to the upside of the stock while the “-1x Short Baidu ETP” (LSE ticker: BIUS) has a payoff similar to a short position without a margin requirement.

PS: The 3x ETP has just started rising on account of the stock’s recent spurt of positive sentiment:

while the -1X ETP has consistently delivered returns well over that of the S&P 500 and Nasdaq-100 over the past three months.

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For broader articles that deep-dives into business and culture in Asia, visit asianomics.substack.com. The latest article discusses the spate of Mercedes Benz BEVs spontaneously combusting across Asia and trends in Benz’ EV sales. Also recently published is the rationale behind my commentary featured in Bloomberg, Fortune Magazine and CoinTelegraph.