Baidu. The most popular search engine in what will soon be the world’s biggest economy. It has over a billion monthly active users and another 275 million that have DuerOS voice assistant (the Chinese equivalent of Siri). And great news. It’s undervalued!
The following report should not be taken as investment advice. It’s my opinion on a stock that I own and will continue to buy.
Baidu is fundamentally strong for many reasons:
It’s a founder led company: Robin who created the company in 2000 still serves as CEO and maintains a large share of the company. Founder companies are often said to have an advantage as they usually prioritise sustainable long-term growth over short term profits. Founder CEOs usually also have significant skin in the game.
They’re expanding into growing markets: In 2017, he announced that the business would begin to shift its business operations from search engine advertising to driverless vehicles and artificial intelligence.
Baidu has had a few bad months and it’s still holding up well: Baidu currently trades at $103, down from a high of over $270 from June 2018. Current price/earnings is 15.75 which is not far off the 16.5 Shanghai Stock Exchange average.
Year on year growth: Baidu published a net income of $3.3 billion in 2018, compared to $2.6 billion in 2017 and $1.7 billion in 2016.
Demographic trends suggest China will begin democratisation soon: According my calculations based on demographic analysis and expert opinions China will begin to undergo democratisation in the mid-2020s which will open a whole new universe of opportunities Internet censorship laws for a search engine are about as helpful as tobacco regulations for cigarette companies. China’s Democratisation process will not ignore the internet in a digital age and after online censorship is rolled back Baidu will experience much more usage and ad revenue will explode.
Strong balance sheet: Total assets minus total liabilities yields $26 billion, which is indicative of a strong balance sheet. With a solid current ratio of 2.61 and $4 billion in cash at present, the company is well poised to make moves into emerging industries
Cheap stock: With an enterprise value of $38 billion and a EBITDA of $4.6 billion in 2018, Baidu has a 8.26 EV/EBITDA. You don’t typically see a ratio this low for such a large technology company. For example, Google has a 13.80 ratio and apple has 13.44 ratio.
Baidu has diversification: the company holds a 70% stake in iQiyi, AKA the “Netflix of China.” Revenue from this business currently makes up around a quarter of their revenue. And whilst Baidu’s advertising revenues are slowing, iQiyi revenue has been steadily growing over the past couple at around 30%.
It’s not all rosy in the short term which makes it attractive to long term punter who are willing to wait for big pay offs. The current sentiment is bearish
The trade war has knocked investors’ confidence in buying Chinese equities. the trade war is something that cannot last forever that benefits investors who are willing to back a dark horse. The difficulties Baidu is dealing with in a rapidly changing tech environment are most likely temporary hurdles than something that will permanently hinder the business.
Baidu did have a big sell-off after releasing Q1 2019 results that revealed a net loss of $49 million, compared to a $670 million gain just a year earlier. But it’s not as bad as it looks as much of this loss can be attributed to a one off large expenditure on the CCTV New Year Eve Gala. This was a one-time sponsorship that cost the company around $50 million, $1 million more than it lost in the first quarter.
Baidu states in its 2019 guidance that it expects little to no sales growth in Q2 2019. Additionally, analysts predict that profits could sink by up to 60% in 2019 and take till 2022 to recover to 2018 levels. Analysing the company’s cash flows, we can see that Baidu posted $4 billion in 2017 and $3.9 billion in 2018. This decrease can be largely attributed to the fact capital expenditures were significantly higher compared to previous years.
It’s important to consider Baidu is undergoing a major shift in operations, and it has shown in the short-term financial results. The Q1 loss and the trade war has emboldened already bearish sentiment about the big moves the company is making.
Assuming that analyst consensus is correct, and 2019 will be a poor year but Baidu will survive. I believe the company will bounce back to the $4 billion range by 2022 and thrive in the mid 2020s when democratisation starts regardless of current obstacles.