The instances are altering for Baidu (NASDAQ:BIDU) (OTC:BAIDF). Having lengthy been China’s main search engine firm and little extra, the corporate is slowly however certainly carving out a brand new management place within the Chinese language synthetic intelligence (‘AI’) area. Since I final coated the title, Baidu has additional constructed on its profitable AI-powered ‘Ernie Bot’ 4.0 (the equal of ChatGPT 4.0) launch, most lately buying over 100m customers since its launch in Q3 final 12 months. With Ernie’s skilled model already monetized for per-month subscription fees as nicely, incremental AI revenues may shock to the upside ahead of many assume. There’s additionally the ecosystem-wide increase from AI synergies to think about, most notably within the internet marketing and cloud companies. Whereas dangers stay, significantly on the geopolitical aspect, as this month’s selloff (triggered by hypothesis relating to navy hyperlinks) confirmed, Baidu’s charge of change is overwhelmingly internet constructive.
Heading into This fall, we could nicely see some disappointment, significantly from Baidu’s promoting enterprise, which stays tethered to slowing Chinese language consumption and financial tendencies. But, there’s room right here for Baidu to defend its margins, given the progress administration has made in its price management efforts. It stays early days however rising, increased margin AI-related income contribution additionally bodes nicely for general profitability.
Baidu’s optionality expands past the earnings assertion, as ‘trapped’ steadiness sheet worth (internet money & equal place at as much as 50% of market cap) seems set to be unlocked by way of buybacks, whereas prepayment restoration (as much as $1.9bn) from the canceled YY Dwell acquisition could possibly be on the desk as nicely. AI or no AI, Baidu buyers pay an affordable earnings a number of (~9x ahead) for a rising enterprise, so even after handicapping the dangers, buyers have some ways to win right here.
Unlocking New Generative AI Income Streams
For all its execution mishaps previously, Baidu has accomplished an amazing job on AI. Not solely was the corporate among the many first to market with its AI-powered Ernie chatbot late final 12 months, but it surely has additionally led the best way in person acquisition, crossing 100m customers this month. Constructing on its AI management over key large tech friends, Tencent (OTCPK:TCEHY) and Alibaba (BABA), Baidu was additionally among the many first to monetize its chatbot, imposing a subscription payment of RMB59.9/month (~$9/month) for entry to its skilled model from November 2023. If AI developments within the West are any indication, generative AI-related revenues will include increased capex but in addition increased margins (>50% gross margins for Anthropic) and thus, show accretive to the Baidu core enterprise.
In contrast to Western generative AI leaders, Baidu has a captive ecosystem by means of which it will probably derive AI-related synergies as nicely. Per administration, name quantity on ‘Wenxin Qianfan’ (i.e., its massive mannequin platform for enterprises) is already seeing important development – a constructive signal for Baidu’s AI penetration all through China’s broader company panorama. Momentum within the advertisements enterprise is one other key constructive, as advertisers more and more go for the extra streamlined, cost-effective course of enabled by Baidu’s new AI-powered digital advert platform. Different verticals have but to be tapped extensively, although even in as we speak’s early phases, AI-related incremental income may show extra significant than many count on within the coming quarters.
Structural Margin Tailwinds From AI
Beneath the income line, proof from Q3 signifies margins are poised to develop as soon as AI features traction. The largest charge of change near-term will possible come from machine studying/AI cloud (presently a low single-digit % income generator), which is guided to see a margin profile considerably increased than the legacy cloud enterprise. Within the possible state of affairs that AI-enabled promoting proves equally margin accretive resulting from its superior value-add to advertisers, all indicators level to Baidu’s working margins shifting structurally increased alongside its AI shift.
There’s additionally probably alternative inside Baidu company for working price efficiencies from the usage of generative AI, although it’s in all probability too early to underwrite any advantages for now. Even balanced towards the overhang from AI chip export restrictions from the US/EU (mitigated near-term by Baidu’s stockpile) and the related opex/capex will increase related to working these fashions, Baidu ought to nonetheless come out nicely forward.
Unappreciated Steadiness Sheet Provides Draw back Safety
As engaging as Baidu’s P&L seems, its steadiness sheet is even higher. Along with its two main monetary stakes (48% of iQIYI (IQ) value $1.7bn and an 8.7% stake in Journey.com (TCOM) value $2.1bn), the corporate additionally has a really sizeable internet money place (roughly half of its present market cap). The present buyback authorization is a constructive first step, although the market stays very reluctant to assign worth to its internet money hoard; continued buybacks ought to however unlock this ‘trapped’ worth over time.
One other fascinating steadiness sheet optionality is for Baidu to claw again a few of its $1.9bn prepayment post-termination of its YY Dwell acquisition. Even when parentco JOYY (YY) efficiently pushes again, the termination announcement remains to be a internet constructive consequence for Baidu following the broader sector de-rating in recent times. Whereas I wouldn’t write in any worth simply but, the market hasn’t both, and thus, any incremental greenback represents a ‘free’ possibility on high of the prevailing fairness worth.
Poised for Upside as AI Monetization Begins
It’s early days for China’s burgeoning generative AI business, and for now, no less than, Baidu seems to be firmly within the lead. Since releasing its AI-powered Ernie chatbot to the general public, the corporate has not solely onboarded >100m customers but in addition begun monetizing by way of month-to-month subscriptions (a la OpenAI). In distinction to OpenAI’s purported ~$100bn valuation, although, Baidu trades at a relatively undemanding high-single-digit a number of on ahead earnings. Positive, the corporate carries baggage within the type of a decelerating (however nonetheless worthwhile) advert enterprise, together with broader geopolitical dangers. However that is greater than offset, for my part, by the AI potential (each by way of Ernie and adjacencies throughout the Baidu ecosystem), in addition to the online money/steadiness sheet worth presently being unlocked. With few positives within the value, I like the chance/reward heading into This fall reporting.
Editor’s Notice: This text discusses a number of securities that don’t commerce on a significant U.S. trade. Please concentrate on the dangers related to these shares.