Last week, Baidu Inc (ADR) (NASDAQ:BIDU) announced that its Chief Operating Officer, former Microsoft Corporation (NASDAQ:MSFT) executive Qi Lu, would be stepping down as COO and transitioning to more part-time duties at BIDU.
The market seems to think that the Lu exit is a big deal. Ever since that announcement, BIDU stock has dropped nearly 15%, equating to a $12-billion drop in market value.
Does this make sense?
Not really.
Lu was widely recognized as the head of Baidu’s AI initiatives, and AI is essentially at the center of everything Baidu does, so it is a big loss. But the loss doesn’t completely derail Baidu’s robust and still-growing AI-powered businesses. AI will continue to be big at Baidu, and it will continue to power robust growth over the next several years.
Nothing about that has changed. Maybe the narrative has hit a near-term road bump. But long-term, Baidu’s AI business will be just fine.
That is why I’m buying the dip on BIDU stock here and now. The stock was red-hot before Lu’s departure, so this selloff somewhat normalizes the price action and sentiment, while also bringing the valuation down into value territory.
Here’s a deeper look.
Why the Market Is Overreacting to Lu’s Departure
For all intents and purposes, Qi Lu was the “AI Guy” at Baidu. And AI is increasingly becoming the growth driver at Baidu.
The China internet giant is in the midst of leveraging AI to strengthen its traditional search business, both through delivering more personalized feeds and creating enhanced monetization tools.
Baidu is also using AI to eliminate clickbait and vulgar content from searches and deliver highly targeted advertisements with high conversion rates. Outside of search, AI is also at the heart of Baidu’s autonomous driving and smart home businesses.
Essentially, AI is at the heart of everything that Baidu presently does. From this perspective, Baidu losing their “AI Guy” is a big deal.
But it still is only one person.
And Baidu AI is far, far bigger than just one person. After all, this is the AI that power’s China’s Google. In broader context, then, it is easy to see that while the Lu departure isn’t good news, it also isn’t bad enough to warrant a 15% selloff.
Moreover, Lu will still be working in some capacity for Baidu and didn’t leave on bad terms. My guess is that there are some health-related issues at play here, as Lu left Microsoft a few years back following a bicycle accident.
Therefore, there really isn’t any reason to believe Lu is leaving because Baidu’s AI business isn’t progressing as hoped. Nor is there any reason to believe that Lu won’t still be assisting in Baidu’s AI development.
All in all, it feels like the market is overreacting to Lu’s departure from Baidu.
Why Baidu Stock Is Too Cheap
This overreaction is creating a golden opportunity to buy the dip in BIDU stock.
This is a big growth story powered by burgeoning AI technology. Last quarter, AI enhancements in the company’s search business drove 31% revenue growth. That robust revenue growth led to equally robust margin expansion, as operating margins expanded a full 9% on an overall basis, and a full 12% at Baidu Core.
Over the next five years, this big growth will inevitably slow but not by much. China’s digital growth narrative is still in its early stages, and for all intents and purposes, Baidu is China’s Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG).
Google has been able to grow revenues at a clip consistently north of 20% for the past several years, so it feels likely that Baidu will be able to post at least 20% revenue growth over the next five years.
That level of revenue growth coupled with healthy margin expansion should lead to robust earnings growth over the next several years. Indeed, in five years, I think BIDU can net at least $20 in earnings per share.
A market-average growth multiple of 20 times forward earnings on $20 implies a four-year forward price target of $400. Discounted back by 10% per year, that equates to a present value of around $275.
Bottom Line on BIDU Stock
Prior to the Lu departure, BIDU stock was slightly overextended on a fundamentals basis. Thus, the departure has caused a sharp drop in share price.
But following this big drop, BIDU stock is now fundamentally undervalued. As such, this is an opportunity to the buy the dip in a secular growth stock.
As of this writing, Luke Lango was long BIDU and GOOG.
