EUR 850.00 For Business Accounts Only

Morningstar | Reducing Baidu’s Fair Value Estimate by 14%; the Worst Is Almost All Priced In

We have reduced Baidu’s fair value estimate to USD 225 from USD 262 following the much worse-than-expected second-quarter revenue guidance and full-year cost guidance. We think the worst is almost all reflected in the share price, and it is a good time to buy wide-moat Baidu. We assume revenue growth of online marketing service is flat in 2019, versus 8% growth previously. Management’s guidance of sequential increase in cost to no more than CNY 1 billion each quarter for the rest of this year implies the total cost of revenue and operating expense should not be more than CNY 106 billion this year, which is approximately 6% higher than our revised estimate. We forecast 2019 operating margin to reach 9.4%, down from 15.2% in 2018.

We expect to see 5% CAGR in online marketing revenue in the next five years, driven by recovery in the longer term. This is because weak macroeconomics (resulting in weaker demand and pricing for ads) and moving customers’ landing pages to Baidu’s platform play an important role for the current weakness. We do not expect these headwinds to persist in the longer term.

Baidu now provides a structured format to display information of the online marketing customers’ websites, instead of having users go to the customers’ own landing pages that have a big variation in quality. The landing pages on Baidu’s platform will be easier to navigate for users and therefore should lead to higher conversion.

We think Baidu will lose some customers who decide not to switch, and for those who have switched, it takes time for them to adapt. For instance, the customers need time to fill out the template of Baidu’s landing pages, which causes disruption. Given search advertising is a proven, effective method to target users, Baidu is dominant in search advertising, and better conversion is the ultimate goal, we expect customers, including those that left, will gradually choose to adopt Baidu’s landing pages. In fact, moving customers’ landing pages to Baidu’s platform is supposed to increase conversion and raise ad revenue in the longer term. As the economy recovers and iQiyi’s in-feed revenue recovers from cleaning up unhealthy ads, we expect Baidu and iQiyi’s advertising revenue to recover strongly from low base. We expect others revenue to grow at 46% CAGR in the next five years, driven by strong growth at iQiyi--53% of the others revenue was iQiyi’s membership revenue in 2018, which grew at 64% in the first quarter, attributed to increasing subscriber number and high quality original and licensed content at iQiyi. IQiyi’s content distribution revenue accounted for 7% of others revenue in the first quarter and grew at a rate of 66%, while 15% of Baidu’s others business was iQiyi’s other business, which grew at 143%. Baidu will spend more marketing dollars up front for app installation and cultivating app usage, revenue generated from the users will occur during the lifetime of the users. Hence, we expect to see revenue grow faster after initial investments. Therefore, we expect operating margin will gradually increase to 12.7% by 2023, still lower than the 15.2% in 2018.