The past few months have been a roller coaster ride for China digital search giant Baidu Inc (ADR) (NASDAQ:BIDU). From the beginning of April to the middle of May, BIDU stock rallied from $220 to $280 thanks to resurgent strength in China technology stocks and a really strong double-beat-and-raise first-quarter earnings report which underscored strengthening long-term fundamentals.
But then Baidu stock dropped off a cliff in May after the company announced that its Chief Operating Officer, former Microsoft Corporation (NASDAQ:MSFT) executive Qi Lu, would be stepping down and transitioning to part-time duties at BIDU. Lu was widely considered to be the “AI guy” at Baidu, and AI is at the core of Baidu’s growth engine. Thus, losing Lu was a big hit and Baidu stock dropped to below $240.
Baidu stock has recovered quickly from that sell-off. It now trades north of $270.
Can this rally continue?
I think so. Baidu recently announced a big partnership with BMW China to develop next-generation Internet-of-Vehicles (IoV) solutions. That partnership underscores that post-Lu, Baidu’s AI initiatives are doing just fine. With the Lu risk seemingly in the rear-view mirror, Baidu stock has visibility to $290 or higher.
Here’s a deeper look.
Baidu AI Is Everything
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, both of which are presently nascent businesses oozing with hyper-growth potential.
So, when Baidu lost their “AI guy”, a cloud started to form over Baidu’s medium- to long-term growth prospects.
But that cloud is now clearing.
Baidu’s recent partnership with BMW China involves developing solutions which connect cars to smart home devices, paving the way for smart driving and, eventually, self-driving vehicles. More importantly, the partnership highlights that everything is okay with Baidu’s AI business. After all, IoV solutions and self-driving are all part of the whole AI growth narrative, and a big partnership in IoV/self-driving is a step forward for Baidu AI.
With more clarity now regarding Baidu’s long-term growth prospects through AI, post-Lu, investor sentiment is building, and Baidu stock is heading higher.
Baidu Stock Could Hit $290 Soon
This rally in Baidu stock should persist.
As with many of China’s hyper-growth tech giants, Baidu trades at a big discount to its inherent growth prospects. This is a company which grew revenues in excess of 30% last quarter and simultaneously drove 900 basis points of operating margin expansion.
Those are big growth numbers. But BIDU stock trades at just 25x forward earnings, which isn’t a big growth multiple.
The only explanation for that multiple would be that growth is projected to slow meaningfully over the next several years. But that thesis doesn’t make sense. 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).
Google has been able to grow revenues at a clip consistently north of 20% for the past several years in the global digital ad landscape which is, on average, significantly more saturated than the China digital ad landscape. As such, it feels like Baidu is a lock for 20%-plus revenue growth over the next several 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. In a best-case scenario, I think BIDU can do about $23 EPS.
At the midpoint, that is $21.50 EPS in five years. A market-average growth multiple of 20x forward earnings on $21.50 implies a four-year forward price target of $430. Discounted back by 10% per year, that equates to a present-day value north of $290.
Bottom Line on BIDU Stock
The big risk at Baidu was that Lu’s departure would seriously dampen medium- and long-term AI growth prospects. But the recent BMW partnerships strikes down that fear, and instead illustrates that Baidu AI is doing just fine post-Lu.
As such, there is clear runway for BIDUstock to trend towards its $290 fair value.
As of this writing, Luke Lango was long BIDU and GOOG.