Baidu (BIDU): Q3 2019 Valuation Update

Quick take on Baidu's (BIDU) Q3 2019 results, which were reported yesterday.

Key business takeaways for me were:

  • Baidu Core, which includes Search (and basically everything other than IQIYI) performed better than expectations. Likely, modest declines in Search are being offset by strong growth in Smart Speakers / Displays and Cloud.
  • Search is not imploding, despite the weak macroeconomic advertising climate. They are having some success in getting users to migrate over to the Baidu App (+25% daily active users - DAU - YoY; +25% in-app search queries YoY). However, these app users are not monetizing as well (yet) as traditional desktop search.
  • Increased consolidation of content / ecosystems into mobile "super-app" silos. Essentially, Baidu is creating it's own sub-internet to answer its user's search queries, since they don't have access to the content of other walled-gardens. (Baijiahao publisher accounts +57% YoY; Smart Mini Apps MAU +157% YoY)
  • Continued growth in DuerOS (Smart Speakers, Smart Display (#2 globally in Smart Speaker shipments; #1 globally in Smart Displays). Although margins are probably thin / negative and the business model here is still unclear, there is likely tremendous value in the voice data / analysis that they are collecting, which will funnel improvements to their Cloud AI platform.
  • Cloud revenue growth is slowing sequentially (Q2: +90% YoY; Q3 +70% YoY) as they place "more emphasis on project margin." As a potential red flag and further confirmation of slowing growth, they will no longer disclose Baidu Cloud revenue separately due to "competitive" reasons. Will need to keep an eye on this as Cloud growth represents a key component of my assessment of long term growth prospects.

Here's an updated valuation, which changes the previous valuation from ($165 -> $150) based on the following assumptions:

  • Slightly increased revenue growth. Stronger Search resilience, balanced by more muted growth in cloud (+7.50% -> +7.77% 5-Year CAGR)
  • Strong reduction in costs from Q2 -> Q3 which should continue to support operating margin story in Core (20.17% LT target)
  • Reduction in share count from share repurchases ($1.2B USD shares repurchased YTD)
  • Reduced probability of stock de-listing / value destruction due to declining trade tensions (25% -> 20% chance of delisting)
  • Reduced effective tax rate based and now using past 5-years as a base rate (20% -> 16.2%)
  • Slight reduction in value of iQIYI stake ($2B -> $1.5B USD)
  • Increased discount rate from (5.75% -> 6.82%). The previous valuation had an error that caused the discount rate to be too high, causing an inflated valuation. On a "constant" discount rate basis, valuation increased from ($142 -> $150).

It's also important to note that this valuation assigns minimal value to DuerOS (Smart Speakers / Smart Displays / Voice Assistant) and Apollo (Autonomous Driving), and is relatively conservative by design. These moonshots could provide significant upside optionality ("On Apollo, we are excited about our progress in early-stage commercialization of smart transportation..."), although the revenue / business models are still unclear, and they may take many years to realize.

In essence, I think you're still getting a decent margin of safety for the core Baidu business, which is proving more resilient than people expected; and the added upside optionality of iQIYI, DuerOS, and Apollo "for free."

Spreadsheets:

  1. BIDU valuation - https://docs.google.com/spreadsheets/d/15386D0GE1TBUhL4F8YjkI18aCG5pfReIjKRQ7L4jbmc
  2. iQIYI valuation - https://docs.google.com/spreadsheets/d/1RRQZhE0W8H_je5uIfNet6YbuvYZr6iyXz1OWiKhrxuM

Disclosure: I am long BIDU

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