Baidu Inc (ADR) (NASDAQ:BIDU) has had a rough couple of years. BIDU stock actually trades about 20% off highs from late 2014, even with 13% gains year-to-date heading into its fourth-quarter earnings report.
It’s hard not to argue that some of the weakness has been self-inflicted. Restrictive laws on online advertising in the medical space were passed in large part to limit ads on Baidu, which still holds 80% market share in search in China. Investments in O20 (online to offline) have hit profitability of late. Overall margins are falling even beyond that effect, and competition is increasing.
There is an interesting (and valuable) company underneath the concerns, however. Baidu often is referred to as the “Google of China,” and its comparisons to Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) make some sense. Like its larger (and more valuable) U.S. peer, Baidu is dominant in search. It’s moving into high-tech fields, such as autonomous driving and artificial intelligence.
But where the companies are different is in execution. While BIDU stock has tumbled, Alphabet stock sits just off all-time highs reached last month. Alphabet has a credibility with investors that Baidu lacks at the moment.
As such, it seems likely that investors won’t be focusing on the numbers in Baidu earnings. Rather, the spotlight will be on what management has to say about Baidu earnings, and how BIDU is responding to its many challenges.
Baidu Has Some Questions to Answer
There’s a ton of potential left in BIDU stock if the company can calm investor fears. Indeed, the relatively skeptical attitude toward the company from Wall Street is reminiscent of that toward Alphabet (then called just Google) in 2011-2012. Google stock then traded at a low earnings multiple amid fears of slowing ad growth and money being wasted on other projects.
The problem ahead of Baidu earnings is that there are a lot of fears to calm. Baidu has invested heavily in its O2O business — which includes markets from food delivery to ride sharing. But the company reportedly has just 14% market share, and Alibaba Group Holding Ltd (NYSE:BABA) and Tencent Holdings Ltd (OTCMKTS:TCEHY) are targeting the space aggressively as well.
After Q3, Baidu did seem to signal a modest change in strategy, however. CFO Jennifer Xinzhe Li said on the third-quarter earnings call that the company would spend on the space “in a very disciplined manner.” And Baidu seems to be targeting more partnerships, along the lines of its deal with travel site Ctrip.Com International Ltd (ADR) (NASDAQ:CTRP).
How quickly the company can respond to the loss of medical search revenue will be important as well. Growth in Baidu earnings and revenue has decelerated dramatically this year. With BIDU stock still trading at 32 times 2017 earnings estimates, investors clearly are expecting that growth to pick back up. If Baidu can convince investors that its strategies in O2O are viable — and working — then BIDU stock probably has some upside out of the report.
Long-Term Opportunity for BIDU
I believe that’s true from a longer-term standpoint as well. BIDU stock looks compelling — if the company can overcome the near-term issues. Those aren’t limited to O2O and search. Competitive concerns remain as well. Baidu wants to push harder into video, with its core search business slowing.
But Tencent is in that space as well, and Alibaba acquired video leader Youku Tudou in 2015. Baidu’s iQiyi video business still isn’t profitable; the company raised $1.5 billion in a convertible bond offering this week to drive further investment. Baidu needs to gain better traction in that space to drive long-term growth. And in the legacy online advertising business, WeChat and Weibo Corp (ADR) (NASDAQ:WB) both stand ready to take ad revenue.
For all the concerns, however, there’s still a huge opportunity here. Baidu already is comfortably profitable, with little in the way of balance sheet worries. Increasing internet usage in China implies years of solid growth in a huge market. Baidu rolled out a “news feed” last year and has begun monetizing the product, a potential boost to 2017 sales. Even just “righting the ship,” so to speak, probably is enough to drive upside in BIDU stock.
After all, BIDU still trades at a multiple not far from Alphabet or Facebook Inc (NASDAQ:FB) despite being far earlier in its market opportunity. It still hasn’t really monetized its maps business. It’s still losing money in a lot of areas, including O2O and video. In both cases, Baidu either can move the businesses to profitability or at the least cut spending. In both cases, earnings growth should continue.
The question is whether Baidu will be nimble enough to make those sorts of moves. If it is, BIDU stock likely is underpriced. The company doesn’t have to win in every area to support its valuation, but that argument relies on management making the right decisions. And that’s why Baidu earnings tonight likely will focus more on those decisions than the numbers driving them.
The author has no positions in any securities mentioned, but may purchase shares of BIDU after earnings.