Baidu: World-Leading Tech Giant on Sale

Originally posted in February 2022

According to Bloomberg, China’s population shrank in 2022 for the first time since Mao Zedong’s Great Leap Forward (1958-1962) and the ensuing famine which starved an estimated thirty million people to death. The cause of the population decline in 2022 is not a result of poor uptake of agricultural collectivization or farmers melting down their tools in order to meet state steel production targets. This time around the population decline is caused by a rising mortality rate due to a much older population (China’s one child policy from 1980-2015 has left only half of the country’s population below 40 years of age) and a rapidly falling birth rate. The extreme cost of raising a child in China may explain why the repealing of the one child policy in 2016 only led to a further decline in birth rates.

Whether or not China’s demographics issue reverses, the nation still has the second largest economy in the world at $18 trillion dollars (growing 3% in 2022), the largest population in the world at 1.45 billion people, and perhaps most importantly a very ambitious, hardworking, and well-educated working age population. Chinese people take pride not only in their country’s collective success, but also their own individual and familial upward economic mobility. The germ of economic growth remains strong in China, and the adventuresome investor would do well to consider an investment in some of the country’s best companies.

In this article I will discuss the merits of an investment in one of China’s largest and oldest internet companies. Founded in the year 2000 by Yanhong “Robin” Li and Eric Xu, Baidu can be called the “Chinese Google”. They have a near monopoly on Chinese internet search and related ads revenues as well as a fast growing cloud computing business and a world-leading autonomous driving program.

Baidu spent most of the new millennium as a rising star in the world of internet stocks, but in recent years its core search and advertising product seemed to reach market saturation and the stock fell out of favor due to its lack of growth. Today, the company’s future looks brighter than ever as it charges forward with a leading autonomous driving product, strong underlying metrics in the core online marketing business, and a couple of in-house produced artificial intelligence (AI) chips for its cloud computing business and its autonomous driving/vehicle program.

Search and Feed - Advertising

According to a Chinese friend, “Chinese people don’t have a choice” when it comes to their internet search platform. With 634 million monthly active users (MAUs), Baidu indeed holds a commanding 75% market share within the Chinese search market (this compares to Google’s ~90% market share in most global markets). Competitors in China include Sogou with a 15% market share, Shenma (Alibaba), Haosou, and Youdao.

Baidu’s core revenue stream is their advertising business which produced 77.5% of revenues, 25.2B RMB (or $3.55B USD) in the latest quarter. Due to apparent full market penetration, this business experienced a lack of growth starting in 2018. The second quarter of 2022 saw a 10% year-over-year decline in ad revenues, but the company reported a 9% sequential (QoQ) improvement in Q3 ad revenues. Growth of the 634M user base is healthy at 5% year-over-year.

The global ads market was weak in 2022. In Q3 Facebook (META) reported an 18% decline in their average price per ad. Baidu has also suffered from falling ad prices, but the underlying metrics of the business are very strong. Mobile search queries increased by double digits year-over-year, and feed distributed through the Baidu App increased by 23% year-over-year. The quarterly Gross Merchandise Volume (GMV) facilitated by Baidu Search also grew by more than 50% year-over-year in Q3. Engagement is strong and as macroeconomic factors and ad prices recover, growth in Baidu’s search/ads business will reaccelerate.

The search business is very attractive because it is a natural monopoly with high margins. The high cost of the infrastructure to crawl, index and efficiently query the entire Chinese internet, means that Baidu is likely to hold its dominant market share for a long time. As more users interact with Baidu’s search platform, it can optimize its ranking system and become more valuable to advertisers, further cementing its leading position in Chinese search. Compared to Google’s 32% Search Operating Margins, Baidu Core’s 26% Operating Margins may even have some room for expansion.

AI/Cloud

Baidu currently holds a 9% market share of cloud computing services in China’s $31.2B USD annual revenue market behind Alibaba Cloud (36%), Huawei Cloud (19%), Tencent Cloud (16%). In Q3 Baidu AI Cloud’s revenues grew 24% year-over-year to 4.5B RMB (18B RMB annualized). This division is still working towards profitability, and Baidu’s second-generation Kunlun AI chip, built on a 7nm process, may advance this effort.

Autonomous Driving Platform - Apollo Go

Baidu’s Apollo Go autonomous driving unit is the furthest along in the world, having achieved Level 4 autonomous driving capabilities and completing 474,000 robotaxi rides in Q3 2022 while also providing a total of 1.4 million robotaxi rides on public roads. Baidu’s Apollo Go has robotaxis completing over 15 rides per day in Tier 1 cities Beijing, Shanghai, and Guangzhou.

Apollo Go is now operating robotaxis in over 10 Chinese cities with more than 10 million in population. Chinese customers have begun to realize that Apollo Go’s AI driver can be safer and better than a professional driver. After all, the AI driver will never get distracted or tired. Baidu’s management plans to expand the autonomous driving operation to more regions in China and to reduce hardware and vehicle costs to the point that the robotaxi is more profitable and cheaper than current ride-hailing services.

EV venture

In order to lower the hardware cost for their autonomous driving business, Baidu (55%) partnered with auto manufacturer Geely (45%) in the joint venture Jidu. Together Baidu and Geely have invested $8B USD in their quest for a low-cost smart electric vehicle. Baidu has also developed an in-house automotive grade AI chip under the name Honghu.

Financials/Closing

The financial case for an investment in Baidu is strong. With almost $12B in net cash, this world leading technology company trades for an enterprise value of only $39B. ~8x 2024E EV/EBITDA presents a highly attractive entry multiple for a business with such growth potential. To boot, the company has a solid share buyback program which has offset share issuances for stock-based compensation since its 2020 implementation and has put the company on a current pace to buyback 2.5% of outstanding shares annually. The company is also in good hands with CEO and 20% equity owner Robin Li, arguably the best CEO in China today.