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Technology Stocks : Baidu (BIDU)
BIDU 117.44-0.2%3:59 PM EDT

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From: Frank Sully9/10/2021 4:57:08 PM
   of 2014
 
Baidu Is Actively Transforming From A Value Company To A Growth Company
Sep. 7, 2021 1:52 AM
Baidu, Inc. (BIDU

Summary
  • Restoring the margin of a large segment of Baidu's business - iQIYI - will increase the total operating margin from 13.4% in 2020 to 17.3% by 2023.
  • News of Apollo's success pushes Baidu's seizure of share in the large market for smart devices, electric vehicles, and urban solutions closer;
  • Disclosure of the value of small innovative businesses that are not included in the market value of the company: Xiaodu and Kunlun.



Yongyuan Dai/iStock Unreleased via Getty Images

Investment thesis

Baidu (NASDAQ: BIDU) is actively transforming from a value company to a growth company. Baidu has several fast growing segments in cloud AI and autonomous driving system. The main business of the company generates stable cash flow to support new high-tech segments - cloud, artificial intelligence, electric vehicles, smart device systems.

We have a positive view of the company's business and believe that now is a good entry point to the company. Baidu is trading at 7.7x EV/EBITDA'22, that is "dirt cheap".

Baidu's business

Baidu is a large Chinese holding company, the main subsidiary of which is the search engine of the same name. Baidu is the dominant search engine in China. According to StatCounter, Baidu is retaining 79.9% of the search engine market share in China, and 1.29% of the search engine market share in the world.





Source: StatCounter

In addition to the search engine, Baidu also owns iQIYI, a Chinese online video and TV streaming platform. Together with Youku and Tencent ( OTCPK:TCEHY), it accounts for 80% of the total video streaming market in China. Baidu owns a 56% stake in iQIYI. Moreover, iQIYI is listed on the exchange (NASDAQ: IQ). Baidu is consolidating IQ's financial results in its financial statements.

In addition to classic advertising businesses, Baidu is actively developing in the fast-growing segments:
  • Baidu Cloud. Baidu Cloud has a diverse lineup of solutions. They include EasyDL (a machine learning service), PaddlePaddle (a deep learning service that, according to GitHub, is among the top 3 of the best ones), the provision of cloud and process automation services, and Baidu Brain (a smart assistant with artificial intelligence). According to China Internet Watch, Baidu Cloud holds 7.2% of the cloud market share in China in Q1 2021.
  • Apollo is a cloud-based autonomous driving system. Apollo has traveled 6.4 million miles on road autonomously, and 600 million miles in test simulations. Apollo has also received a permit for night driving under special weather conditions in the capital of China - Beijing - and two other major cities.Jidu is a joint venture between Baidu and Geely ( OTCPK:GELYF) to develop smart electric vehicles. The company has been established only recently. The first models are planned for release in 2023.
  • Baidu Core: SearchThe Baidu search engine is the company's main asset. Search generates both most of the company's revenue and most of the company's operating profit.

In 2016, Baidu had 79.1% of the search engine market share in China, and every year until 2021, the company was losing market share. By the end of 2020, Baidu's share was only 69%.

The search engine Sogou (NYSE: SOGO) is to blame for that. In 2013, Sohu (the creator of Sogou) entered into a partnership with Tencent. Sogou has integrated a classic search engine with WeChat (the most popular social network in China with over 1.1 billion users) and QQ (a social platform for games, music, shopping, microblogging; it is the second most popular website in China and the fifth most popular in the world). Tencent was able to develop Sogou due to its technology. It also attracts advertisers due to the better user personalization. Sogou knows not only what the user is looking for on the web, but also what they are watching/playing/listening to on QQ and what they are talking about on WeChat.

Everything changed in Q1 2021. Sogou earned 47% less than Q1 2020. Tencent said it wanted the company to be private (Sogou is now listed on the exchange). The announcement sparked uncertainty among Sogou's major clients regarding the new business policy. Additional customer churn was caused by the announcement that Sogou will spend less on driving traffic to its search engine. Because of this, Sogou's share in search fell from 20% to 11% and customers started using Baidu.



Source: Company Data, StatCounter

Baidu Search Prospects

Search advertising is one of the market segments of digital advertising. eMarketer predicts that China's digital ad market will grow by an average of 15% over the next three years. At the same time, the search advertising market will grow at a rate two times slower than the digital advertising market. This is because the advertising market is moving to social media and social websites. Social activities talk about a person, their interests, and values much more than ordinary surfing on the Internet. Most advertisers are looking for these personalized solutions to help them reach out to their customers. Search will remain a major part of the advertising segment, as it allows to tell a large number of people something, but niche services are moving to social media networks. As a result, the share of search from the digital advertising market will decline from year to year.



Source: eMarketer

We expect that the decline in Sogou's share in the search engine segment for China will be short-term, as it is associated with emotional factors. Sogou has an important advantage over Baidu - it has the access to a detailed portrait of each user, thanks to the integration with WeChat and QQ. We expect Baidu's share of search to shrink by 2% to 77.9% by the end of 2021. And then every year until 2023, it will decrease by another 4% and will reach 70% by the end of 2023:



Source: Invest Heroes' estimates

Baidu Core: Cloud technologies

Baidu has successfully entered the cloud technology race in China. Overall, the cloud market in China is dominated by 4 major players. Alibaba has the largest share:



Source: Statista

Baidu is developing cloud in several directions:

EasyDL is a simple machine learning service. It was named the best in China by IDC twice;PaddlePaddle is a deep learning platform, among the top 3 in the world in terms of the number of uses on GitHub;AI Baidu is a cloud platform (PaaS) using artificial intelligence. Baidu platform is different from Alibaba Cloud. Alibaba provides the infrastructure (IaaS) on which the decisions of the companies are superimposed, that is, the foundation. Baidu, on the other hand, provides a platform within which there are ready-made solutions: the foundation plus the frame of the house. For example, one of the largest banks in China has fully automated customer interactions and lending using the Baidu platform. The largest TV channel in China, CCTV, has automated the creation of video clips and video tagging in live broadcast mode. More advanced cloud technologies are called SaaS platforms which consist of the foundation plus the frame of the house plus all the stuff of the house. It means they are ready-made solutions that are implemented without any integration with internal data sources.Cloud ProspectsBaidu Cloud has grown at an average of 50% YoY over the past two years. This is not surprising. Baidu entered a fast-growing market with new technologies and monetized its large customer base. For the forecast period, we conservatively forecast the growth of Baidu’s Cloud segment at the level of the growth of the Chinese cloud market.

According to various analytical agencies, the cloud technology sector will grow by 18% YoY globally. However, the Chinese cloud market is growing significantly faster. The current share of the Chinese market is only 7%, and analysts predict a global share of China at 10.5% by 2023. This corresponds to a growth rate of more than 30% YoY through 2023.



Source: Invest Heroes' estimates

Baidu Core: other businesses

The rest of Baidu Core's businesses include:

Xiaodu is the world's best manufacturer of smart displays, speakers, and tablets, according to IDC;Kunlun is a semiconductor manufacturer for cloud infrastructure. According to Baidu, Kunlun received its first round of investments with a total valuation of $2 billion.Apollo and Jidu, which were discussed above.

Xiaodu and Kunlun operate in China's fast-growing markets. ReportLinker expects the global smart display market to reach $15.1 billion. The market is growing at an annual rate of 22% YoY.

Research and Markets estimates the smart speaker market will reach $17.8 billion by 2027. The fastest-growing country will remain China, where annual market growth is estimated at 26% until 2027.

We estimate the growth of the Hardware segment excluding Apollo and Jidu at 32% YoY through 2023:



Source: Invest Heroes' estimates

Baidu Core: Apollo

Apollo works in three main areas:

Smart cars. Apollo provides access to CarLife+, a system that collects a wealth of vehicle data and turns the vehicle into an Internet of Things object. With CarLife+, the driver can find out everything about the condition of any part at any time. It also includes the DuerOS system, which is a smart onboard computer with voice recognition. Other offerings include smart cards and a smart parking system.Smart transport. Apollo partners with city services and provides them with various solutions to road problems. Apollo now has two solutions: smart traffic lights, according to the company, accelerate traffic by 20-30% during peak hours; and V2X, a roadside object recognition system.Autonomous driving. Apollo develops both a private autopilot for electric cars and a system of robotic taxis and minibuses. Apollo has hit over 6.2 million miles on the road. Apollo has also received dozens of permits for testing fully autonomous driving in major cities, including Beijing. Moreover, the minibus system already covers 30 cities, in which more than 89 thousand passengers are transported.Apollo has a very high potential, with only the robotaxi market in China estimated at $224 billion, and Apollo providing the most technologically advanced and comprehensive solution on the market.

First of all, when analyzing Apollo's results, we start from Baidu's predictions, which follow the earlier outlined plan. After all, China is a planned economy, and there, guidance speaks volumes. Furthermore, given that Apollo has received permission in Beijing, the state actively supports Apollo.

According to the GS Research data, the CarLife+ system is used by about 10 million users at an average price of 20 yuan per year. DuerOS is used by about 1 million users at an average price of 250 yuan per year. The smart parking system is used by about 100,000 people at an average price of 10,000 yuan per year, and the smart card system is used by about 280,000 people at an average price of 500 yuan per year.

We assess the potential of each sub-segment according to the company's forecasts and the growth rate of the autonomous driving market in China:



Source: Invest Heroes' forecast, Company Data



Source: Invest Heroes' forecast, Company Data

Based on the average prices and installations, we predict a smart car segment revenue of 6.6 billion yuan by 2025. Average market growth is estimated at 26% annually.

Baidu expects the smart transportation system to cover 100 cities by 2023. Each new contract is estimated at an average of 100 million yuan per year, and the renewals of already signed contracts are estimated at 40 million yuan per year.



Source: Baidu's guidance, Invest Heroes' estimates

Baidu predicts that the number of robotic taxis will reach 3,000 by 2023, and more than 12,000 by 2025. At the same time, Baidu does not create a new player in the taxi market, but enters into collaborations with local players, for example, DiDi (NYSE: DIDI). This means that taxis and Baidu will share the trip revenue among themselves in a certain proportion, for example, 50/50. Taking into account 12,000 robotic taxis in 2025, the average number of trips per day is 12, robotaxis will make 52.5 million trips. Adjusted to inflation, the average price of a trip in China will reach 32 yuan, bringing the operator's total earnings to 1.7 billion yuan. With an equal division of income, Apollo will receive 870 million yuan.

As a result, we estimate Apollo's total revenue in 2025 at 18.6 billion yuan:



Source: Baidu's guidance, Invest Heroes' estimates

Baidu Core: Jidu

Jidu Auto is a joint venture between Baidu (55%) and Geely (45%). According to the executive director of Jidu, the first electric car will go into production in 2023.

Jidu will release its first electric vehicle which will look like a robot and will target the younger generation. Also, the company is not going to use dealer services for the sales of electric vehicles.

The Jidu vehicles will use Geely's open-source platform and are being built at Geely's factories. Baidu will most likely take over all the technological equipping of the electric car. In addition to technology, Jidu is considering using Baidu's semiconductors.

We believe that Jidu will enter the market in 2023, as they are the first to create a robotic car. In addition, by that time, Apollo and other Baidu technologies will have time to establish themselves not only for the Chinese audience but also for the international audience, thanks to the Winter Olympic Games in Beijing in 2022.

We expect that in 2023, the company will be able to produce 60 thousand cars and increase production to 240 thousand by 2025. Taking into account the average selling price of an electric car of 150 thousand yuan or 23 thousand dollars, Jidu will earn 48 billion yuan in revenue in 2025:



iQIYIiQIYI is one of the largest streaming platforms in China. iQIYI specializes in streaming long videos and TV shows. iQIYI is the largest streaming platform in China with over 500 million monthly users. Now, the number of paying users reaches 105.3 million (-11% YoY).

The customer churn occurs because iQIYI is cutting back on content investments and raising subscription prices. That is since Baidu is trying to cut its losses. Despite its leading position in the industry, iQIYI continues to be unprofitable.

iQIYI will begin to lose market share as the video streaming sector in China is growing 22% YoY. However, video streaming is growing mainly due to short video services like TikTok. At the same time, long videos and series are less popular.

We expect stagnation in the number of monthly active users and slower growth in advertising revenue due to maintaining a stable customer share. Now iQIYI holdsabout 30% of the video content market and 40% of the video content market for children.

In this regard, we expect that IQ will earn 30.8 billion yuan in revenue in 2021, as we do not expect a significant decrease in regular users of the platform. At the same time, given that the platform does not seek to reduce the turnover of premium content, we expect an EBITDA loss in 2021 of 3.3 billion yuan. But we still expect iQIYI to be able to reach the operating income in 2023:



Source: Invest Heroes' estimates

Q2 Results. Baidu Accelerates AI Deployment

Today, Baidu is heavily focused on deploying its AI systems more quickly, so it is raising R&D spending and capital expenditures.

Baidu Cloud is growing twice as fast as the Chinese cloud market. In the last quarter, the growth was over 65% YoY. Baidu has been named the Top 1 AI Cloud Infrastructure Provider in China by IDC. In Q2 2021, Baidu signed two additional major contracts. Geely, a major automaker in China, will digitize its business with Baidu's solutions. Baidu will move Geely's business to cloud infrastructure, streamlining manufacturing, and management processes. Geely will provide cloud solutions for its suppliers and customers. Baidu has also deployed an intelligent water treatment plant monitoring system in a Chinese city with 8 million people. A machine learning model for predicting water use and adjusting water pressure has reduced electricity demand by 8%.

Apollo is also growing rapidly. In Q2 2021, Baidu introduced the Apollo Moon, the fifth generation of Apollo Robotaxi, with a 60% reduction in mileage. The 4th generation Apollo has traveled 12 million kilometers on road and has received 278 permits. Apollo continues to develop its smart city systems. ACE Smart Transportation has signed agreements with 20 cities. ACE re-signed agreements with 9 cities to test the next generation of ACE. Robotaxi Apollo Go expanded its operations in Guangzhou with 47 thousand trips (+200% YoY). Apollo Go is rated 4.9 out of 5 by users. Great Wall Motors, the largest pickup truck manufacturer in China, will supply Apollo's automatic parking system to its flagship WEY-Mocha SUV. Furthermore, the operating system for cars, DuerOS, has been installed on 1.8 million cars (+265% YoY).

Other growth initiatives are also showing good results. Xiaodu remains the best supplier of smart displays in the world and smart speakers in China. Xiaodu is actively used by the elderly people in China, of which there are already 300 million people. Xiaodu smart displays connect seniors as a community and serve as a virtual companion in conversational AI, improving their quality of life and allowing family members to monitor the health and safety of their loved ones remotely. Xiaodu recently closed a new round of investments valued at $5.1 billion. In November 2020, the company was valued at $2.9 billion.

Baidu's growth costs moneyIn addition to continuing to invest in content to maintain consistent subscriber levels amid rising subscription prices, iQIYI is also stepping up investment in development to support the rapid growth of Cloud and Apollo. As a result, prospects for Baidu are growing, but, the business margins are falling. Let us remind you that we do not expect Baidu to retain the current search engine market share. Earlier this year, Baidu gained 10% in search engine market share only by changing the terms for advertisers of another search client, Sogou. Tencent decided to make the search engine private and implemented new terms, which caused the share to fall from 20% to 10%, and, the revenue fell by 50%. We expect Baidu's search engine market share to recover to 70% by 2023.

As a result of Baidu's increased investment and the slower recovery in iQIYI's margin, we expect Baidu to generate EBITDA of 22.7 billion yuan in 2021 and 28 billion yuan in 2022.



Source: Invest Heroes' estimates

Conclusion

Baidu is actively transforming from a value company to a growth company. The main business of the company generates stable cash flow to support new high-tech segments - cloud, artificial intelligence, electric vehicles, smart device systems.

We have a positive view of the company's business and believe that now is a good entry point to the company. Baidu has several drivers for growth:

Baidu's overall margin growth is driven by iQIYI's margin recovery. iQIYI's margins have grown for 5 consecutive quarters since the price hike on subscriptions. At the same time, business growth is slowing down. iQIYI is following the path of Netflix, investing in premium content, which retains the existing customers - about 105 million people - despite the rise in prices.News of Apollo's success. The more contracts and approvals Apollo gets, the closer the huge market for smart devices, electric cars, and cities will be to Baidu.Further disclosure of the value of innovative segments.We value the company at a target EV / EBITDA multiple of 11.9x, which was calculated based on historical multiples excluding investment cash flows and EBITDA growth. Accordingly, we estimate the fair value of Baidu shares over the next 12 months at $233/ADS. BUY.

Risks

The main risk for a large Chinese company is a regulatory one. It is not known if any of Baidu's businesses will come under additional regulatory oversight from the Chinese authorities. If the intervention of the authorities happens, then it can significantly change the landscape of the industry and its prospects.

The second risk is the ability of IQ management to successfully continue to restore the company's margins and bring it to profit. IQ marginality stagnation will continue to hurt Baidu's core business and slow the growth of other initiatives.

The third major risk is the timely launch of Jidu's EV production and Baidu's ability to provide a competitive edge over other major EV makers. If Apollo systems fail, Baidu could will lose market share in the promising electric car market.

Authors: Aleksandr Sayganov, Dmitriy Novichkov

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