Baidu Faces Headwinds as Regulatory, Competitor Pressures Mount

By Fan Yu, Epoch Times
September 4, 2016 4:00 pm Last Updated: September 4, 2016 4:10 pm

 

Baidu Inc.’s standing amongst China’s elite internet triumvirate is on shaky ground as the company battles slowing sales growth, regulatory uncertainty, and an ongoing cash burn from diversification.

The company has a near monopoly on China’s internet search business after Google exited in 2010. But the business environment is deteriorating and its efforts to diversify away from search—which generates over 90 percent of Baidu’s revenues—have not yielded returns. While second-quarter sales increased 10 percent, profits dropped 36 percent year over year, the biggest quarterly decline in the company’s 11 year history as a publicly traded entity.

Baidu’s U.S.-listed ADR shares are down around 6 percent year-to-date. Its market capitalization is now dwarfed by other members of the “BAT”—China’s big three internet giants of Baidu, Alibaba Group, and Tencent Holdings.

Baidu_Alibaba
Baidu (BIDU)’s market cap compared to Alibaba Group (BABA) and Tencent Holdings (TCTZF) during the last five years. (YCHARTS)

Regulatory Headwinds

Baidu derives an overwhelming majority of its sales from search advertising, putting the company at the whim and mercy of the Chinese Communist Party, which maintains tight control over the country’s Internet search framework.

Once a darling of the Party, Baidu has found itself increasingly marginalized by its regulatory changes. Beijing recently announced guidance requiring online advertising companies to restrict the number of advertising to less than 30 percent of each page. An additional wrinkle mandates that all online ads also must be clearly designated as such to help consumers differentiate between sponsored and true search results.

Once a darling of the Party, Baidu has found itself increasingly marginalized by its regulatory changes.

Regulatory restrictions were enacted following an investigation of Baidu earlier this year after a college student died from a cancer treatment advertised online that the student found via Baidu’s search engine. Additional limitations were placed over online advertising of healthcare services.

These constraints have put a damper on Baidu’s advertising revenue growth by “reducing the number of online clients” available to the company, CEO Robin Li said last quarter regarding the change while lowering organic growth guidance from 9 percent to 5 percent for 2016.

The unfavorable regulatory environment has dampened some analysts’ expectations of its stock. JP Morgan’s Alex Yao holds an “underweight” rating on Baidu shares—a minority as most analysts polled last week by S&P Market Intelligence had “outperform” ratings—with a lowered price target of $164, or around 8 percent below Sept. 2 close. Nevertheless, several analysts, including those from Oppenheimer and Piper Jaffray, lowered their price targets over the last month, reflecting a downward shift in sentiment.

Advertising Shift

A big part of JP Morgan’s downbeat assessment of Baidu is due to the industry shift of advertising dollars away from search engine into social media channels.

Look no further than Tencent, which is eating Baidu’s lunch in online advertising. Tencent is China’s social media and mobile gaming king, and its surging advertising revenue growth has reflected the paradigm change in online advertising. Second quarter data showed a 60 percent increase in online advertising revenues to a record 6.5 billion yuan (about $1 billion).

Part of that is due to consumers’ shift from computers to mobile, benefiting Tencent’s mobile platform Weixin/WeChat, which counts 800 million users. Tencent has leveraged the platform to distribute mobile games, video content such as Hollywood movies, and NBA basketball games.

The company has historically generated most of its mobile revenues from in-game purchases. But taking a page from Facebook’s recent success, Tencent has worked to monetize its user base by aggressively pushing mobile advertising within its WeChat app, whose functionality includes mobile chat, news, social updates, and mobile wallet.

Diversification

With its bread and butter online advertising facing headwinds, Baidu is actively searching for an alternative future profit center by deploying billions into potential new technologies, with a focus on artificial intelligence (AI).

Last week, Baidu and American computer graphics media company Nvidia Corp. announced they were collaborating on a platform for semi-autonomous cars. Details were vague during the unveil at Baidu World conference on Sept. 1, but Nvidia CEO Jen-Hsun Huang said the partnership will allow “Baidu to get a self-driving taxi fleet on the road, and the same platform is also designed for use in OEM cars, tied into the same network.”

While Nvidia has dabbled in self-driving cars for years, a host of deep-pocketed companies from several sectors are all vying for a breakthrough in this platform. Technology giants such as Alphabet and Apple, car companies such as Tesla and Volvo, and taxi companies such as Uber are all aiming to bring autonomous driving technologies to market.

To help drive artificial intelligence innovation, Baidu open sourced one of its key machine learning platforms called PaddlePaddle by freely offering the software to AI experts.

Following the footsteps of Microsoft and Amazon, Baidu is releasing its toolkit to attract AI talent and in turn help shape the development of a nascent field that could underpin future consumer-based technology.

Baidu hopes its tools will catch on. Xu Wei, head of PaddlePaddle development at Baidu, told technology focused website The Verge that its AI platform needs only a quarter of the code necessary compared to rival platforms for the same machine translation software.

And some of the company’s existing efforts haven’t panned out. An example is recent cancellation of Baidu’s food delivery drone program called Baidu Takeaway, created in 2015 to provide drone-based food deliveries. But Baidu decided that the food-delivery market isn’t scalable enough to profit, given that Baidu doesn’t have manufacturing facilities for drones.

With none of the above technologies ready to bear fruit in the near future, it begs the question—can Baidu’s long view ease short and medium-term pressures on its shares?