Baidu: Using AI To Create A Better World

Summary

  • Baidu easily beat Q2’21 analyst estimates, but the company provided soft Q3’21 guidance.
  • The Chinese company made the case for using AI technology to make the world better for Chinese citizens.
  • The stock is exceptionally cheap based on normal valuation metrics, but Beijing risk remains high.

Baidu remains a promising tech giant in China, yet the stock has collapsed this year. As Chinese regulators hit the sector related stocks, Baidu made a great push into how their AI-powered technology lowers costs and increases inclusivity for regular citizens in the communist country. My investment thesis is Bullish on the stock due to very encouraging growth prospects of the Chinese tech giant.

Strong Quarter

The Chinese tech giant continues to report strong quarterly numbers with Q2’21 core revenues surging 27%. Even the more mature online marketing business grew revenues 18% to reach $2.95 billion. The iQIYI (IQ) business continues to struggle with only 3% growth in the quarter while the promising AI business surged 80%.

Baidu has become a profit and cash flow machine in the last few years after exiting high cost transaction businesses. For Q2’21 alone, the company generated $1.07 billion in free cash flow, or $843 million when including the iQIYI media business.

The Chinese tech giant has long had strong margins in the online marketing business which includes the internet search site. The ultimate operating margin for the company is highly based on the impact of other businesses owned by Baidu over the last few years.

For Q2’21, Baidu had core operating margins of 27%. The company has long had core margins to rival and even top those of the tech giants in the U.S.

The Chinese tech giants guided to Q3’21 revenues of between $4.7 billion and $5.2 billion for a growth rate of 8% to 19% while the core revenues are expected to see slightly faster growth. The guidance is disappointing considering analysts had a forecast for Baidu to reach $5.19 billion for the quarter, although a typical beat would leave the Q3’21 results similar to original expectations.

The Chinese economy has shown signs of slowing recently due to the COVID-19 Delta variant impacts, leading partly to Baidu lowering expectations. The company saw revenues hit hard back in Q1’20 when revenues fell 9.5% as major parts of the Chinese economy were under lockdowns.

Baidu now has a total cash balance of $27.9 billion offset by ~$12.1 billion in debt. The Chinese tech company now has net cash of $15.8 billion, leaving the stock with enterprise value of only $36.9 billion.


Data by YCharts

The market has generally missed that the EV for Baidu is near decade lows despite substantial sales growth during the last decade. This valuation amount doesn’t even factor in $15.7 billion in long-term investments that would vastly lower the EV of the stock.

AI-Powered Tech Improvements

Chinese regulators have really cracked down on technology companies deemed to hurt regular citizens leading to a new 5-year plan aimed at exerting more influence over tech firms. Education tech firms were slapped down for charging absorbent prices for student tutoring services and restructured as non-profits, the Ant Group  IPO was shelved over risk to the Chinese financial system and the ruling communist party and DiDi Global had cybersecurity concerns hit the recent IPO and now faces issues over the rights of drivers.

The news flow suggests all Chinese tech firms are at risk of repercussions from technology platforms not built for the best interest of consumers and the political leaders. Baidu took to the offensive via the Q2’21 earnings call to suggest their Apollo platform will lower the cost of transportation while Baidu Health will improve health outcomes for citizens and smart transportation initiatives will improve congestion and lower the use of natural resources.

The big question is whether Chinese regulators agree with this thesis of Baidu creating a better world for China. After all, robotaxis eliminate jobs for ride-hailing drivers, so one will have to question if the government allows Baidu to make excessive profits off eliminating these jobs.

Baidu suggests the latest addition of Apollo lowers the cost of AVs by 60%. The new tech will eventually lead to robotaxis lowering the cost of transportation, especially compared to ride-hailing apps requiring a human driver or regular taxi services.

Baidu already provided 47,000 rides in Q2 via the Apollo Go ride-hailing service and expects to expand to a 4th city of operations soon. The ultimate goal is to reach 30 cities in the next 2 to 3 years while again lowering the costs per mile via each new iteration of Apollo.

The company has now provided 400,000 rides and driven 8.7 million miles via the Apollo autonomous driving service. At Baidu World 2021, CEO Robin Li unveiled Luobo Kuaipao, new robotaxi mobile platform, to move the business into commercial operations and shift away from the technical verification stage.

The whole AI-powered segment saw Q2’21 revenue surged by 80% to reach $771 million in the quarter. The AI Cloud business is very sizable now and other businesses like autonomous driving, smart assistant and smart transportation are promising growth drivers. These businesses now account for over 20% of the core revenues and will drive growth higher in quarters not impacted by the communist government decisions or Covid slowdowns.

Takeaway

The key investor takeaway is that Baidu is an exceptionally cheap stock, though Beijing-related risk is high. The stock only trades at 1.6x 2022 EV/S multiples without even factoring in a sizable investment portfolio. Investors should continue looking at further weakness as an opportunity to acquire the Chinese stock on the cheap, though high levels of risk exist.

Author: Stone Fox Capital, Seeking Alpha

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