Baidu Inc. (BIDU, Financial) is often referred to as the “Google of China.” The company runs the largest search engine in the country with a dominant market share. It also is an artificial intelligence leader and was the first Chinese company to release a ChatGPT equivalent, called Ernie Bot, in March 2023. Its core business has also been producing solid growth. Therefore, in this discussion, I will break down why Baidu could be the number one AI stock in China. Let's dive in.
Business model
Similar to Alphabet Inc.'s (GOOG, Financial) Google, Baidu generates the majority of its revenue through search engine advertising. This displays ads to users based on expected intent. For example, if a user searches “plumbers near me,” then an ad relevant to a local plumber shows up.
Advertising is one of the highest-margin and most scalable business models in the world. However, this only works long term when advertisers actually get a return on investment on their ad dollars. In Google's case, the average ROI for every $1 invested is $2. Therefore, I would expect a similar ROI version for Baidu.
The company has also built a thriving app ecosystem, which includes maps, video streaming, music and much more. In addition, it operates the largest video streaming platform in the country, iQiyi, which is the equivalent of YouTube in the West.
Cloud and AI
Baidu is the fourth-largest cloud provider in China with around 9% market share, according to Canalys data. This is behind Alibaba (BABA, Financial) Cloud, which has 36% market share, Huawei (19% share) and Tencent (TECHY) (16% share).
The company is integrating the generative AI tool (Ernie Bot) into many parts of its business.
In search, Baidu is testing the Ernie Bot to help improve conversational queries. The business is also testing integrations with Baidu Wenku, a platform used for sharing documents online. This can help users to search and generate content through AI.
Other areas of the business which are expected to include Ernie Bot include Baidu Map, the Baidu keyboard and even its smart speaker (Xiaodu).
Its cloud enterprise customers have also begun AI model training on the Baidu cloud, which is a testament to the expanding total addressable market. For example, in the financial services industry, the business partners with a large insurance company to help enhance digital experiences for both the customer journey and employee operations.
Online travel companies are also finding value in leveraging the Ernie Bot to assist in managing customer queries, suggesting trips and directing customers. An education company is also leveraging its Ernie Bot to create an AI tutor for students.
In the software industry, Baidu is testing its Ernie bot for automating workloads and as a coding co-pilot.
Baidu’s advantage over other technology giants in China is its ownership of PaddlePaddle, which is a leading deep-learning framework. By improving the integration with this framework, the company can improve the efficiency of its systems.
China’s self-driving leader
Baidu claims its Apollo Go platform is the largest fully autonomous ride-hailing service in the world.
The business enabled a staggering 660,000 rides to the public in the first quarter alone. Its service is now enabled across four Chinese cities: Wuhan, Chongqing, Beijing and Shenzhen.
The company is also focusing heavily on reducing both labor and hardware costs in order to drive greater operational efficiencies.
Strong financials
Baidu reported strong financial results for the first quarter of 2023. Its revenue was $4.3 billion, which rose by 10% year over year.
Baidu Core drove the majority of these results with $3.16 billion in revenue reported, up 8% year over year.
This is broken down in its online marketing revenue, which rose by 6% year over year. Its non-online marketing revenue was $865 million, up 11% year over year.
These results were driven by a “reopening” of the economy and a return of advertisers to the platform. Its search e-commerce gross merchandise volume also grew by 55% year over year, which was fantastic. Its App user MAU rose by 4% year over year.
Moving on to the AI cloud, it rose by 8% year over year to $576 million.
Its revenue for the iQIYI video platform was $1.1 billion, up 15% year over year.
Margins and balance sheet
Moving on to its expenses, the company reported a 3% decline in its cost of revenue to $2 billion, driven by improved operating efficiencies across Baidu’s core business.
Its operating expenses rose by 11% year over year to $1.5 billion, while its operating income was $725 million, up a fantastic 77% year over year.
Overall earnings per share were $2.28, topping analyst forecasts by $1.05.
Moving on to free cash flow, the company reported $3.3 billion. Baidu has a robust balance sheet with $26.6 billion in cash and short-term investments. and total debt of $13.7 billion, which is mostly long term.
Valuation
Baidu trades with a price-sales ratio of 2.42, which is lower than its five-year average.
Further, the non-GAAP price-earnings ratio of 14 is below its average for the same period.
Based on its historical ratios, past financial performance and analysts' future earnings projections, the GF Value Line indicates a fair value of $148 per share. Therefore, the stock was modestly undervalued at the time of writing.
Final thoughts
Baidu is a dominant Chinese technology company that is really spearheading the AI industry. The company has a huge opportunity to recreate the success of Open AI’s ChatGPT with its Ernie Bot in China. Even without this, its core business is firing on all cylinders. Given its valuation is also fairly reasonable, Baidu looks to be a great long-term investment. The only major risk is a political one with reference to Chinese regulators, which is an overhang one must be aware of when investing in China.
