The bottom is falling out for Baidu (NASDAQ:BIDU). Baidu stock fell by almost one-quarter on Friday and Monday. Excluding a very brief dip in 2015, BIDU stock now sits at its lowest level in almost six years.
The near-term catalyst has been BIDU’s disappointing first-quarter report issued on Thursday afternoon. But there’s more weighing on BIDU stock than just a single earnings report. As I wrote earlier this year, there have been significant concerns about the health of its business for a long time.
Its Q1 results and, perhaps more importantly, its Q2 guidance, suggest those concerns are quite realistic. And so I wouldn’t recommend that investors try and time the bottom of BIDU stock just yet.
On the surface, Baidu’s earnings look modestly disappointing, but they don’t seem bad enough to drive such a steep fall. Adjusted earnings per share of 41 cents did miss analysts’ consensus estimate by $0.16. But its revenue growth in Chinese yuan rose 15%, in-line with the consensus outlook, and its sales actually grew 21%, excluding the divestiture of a number of its businesses last year.
The earnings miss sounds disappointing, but the overall numbers don’t seem terribly out of line. The company’s revenue is still growing. BIDU had warned that its profits would drop in the first half of the year, partly due to higher spending on its search business.
But looking more closely, two factors drove Baidu’s top-line growth. The first was its ownership of iQiyi (NASDAQ:IQ), the so-called Netflix (NASDAQ:NFLX) of China. Baidu still owns roughly two-thirds of iQiyi, so IQ’s results and its growth are reflected in Baidu’s consolidated numbers.
But Baidu’s online marketing revenue, the key part of its wholly-owned business, increased just 3%. And Baidu spent an enormous sum on marketing in the quarter. SG&A, which includes marketing expenses, rose a stunning 93% year-over-year. Some of that increase was due to BIDU’s efforts to support iQiyi’s growth. But the operating income of Baidu’s core operations plunged a stunning 67% year-over-year.
Outside of iQiyi, then, Baidu essentially bought, at an expensive price, what little revenue growth it could muster. And Q2 isn’t going to be much better. Baidu guided for consolidated revenue to rise just 1% to 6% excluding divestitures, representing a significant slowdown.
The Baidu Stock Price Plunge
So the reaction to the earnings report does make some sense. Baidu’s stake in IQ accounts for roughly 20% of its market cap; IQ shares have fallen on BIDU’s results. BIDU’s legacy business seems to have a significant top-line growth problem. And its increased spending is causing its profits to not only decline, but to decline sharply. BIDU stock simply has a very different fundamental profile after its earnings than it did previously.
Beyond the numbers, the results confirm the fears that have dogged Baidu stock for some time. Its desktop search business is being displaced by greater use of apps, which bypass browsers and Baidu altogether. (That is also a concern for Alphabet (NASDAQ:GOOG,NASDAQ:GOOGL), to which Baidu is often compared, though Alphabet has done a better job of holding onto its business.) Baidu has added some self-inflicted wounds, including a scandal surrounding medical search results back in 2016 and complaints about its news results earlier this year.
BIDU managed to come out the other side of the 2016 scandal. But its Q2 guidance, in particular, suggests a deceleration of growth to levels not seen since 2016-2017. That, in turn, implies that Baidu’s brand in China has taken another hit from which it may not be as easy to recover.
Outside of search, Baidu hasn’t proven it can win. Its income from equity investments (which does not include iQiyi) declined 57% in Q1. Its efforts in artificial intelligence and the cloud don’t appear to be moving the needle much. If Search starts to fade, it’s not clear that BIDU will have an answer.
Baidu Stock Doesn’t Look Cheap Enough
Baidu stock looks awfully cheap on the surface. The company closed Q1 with over $18 billion in cash, excluding the funds held by iQiyi. Its stake in IQ is worth close to $10 billion. Combined, those assets support over half of the current market capitalization of BIDU stock.
Based on those assets and analysts’ 2019 consensus EPS estimate, it appears that Baidu stock is trading at a single-digit multiple to the profits of its core business. But it’s worth noting that those EPS estimates are going to come down, and potentially sharply, in the wake of the Q1 results. BIDU stock may look cheap, but there’s a wealth of evidence at the moment which suggests that it should be cheap.
Meanwhile, the trade war still hangs over all Chinese stocks. But Baidu stock has badly lagged even its peers recentl. Big Chinese names like Alibaba (NYSE:BABA), JD.com (NASDAQ:JD), and Tencent (OTCMKTS:TCEHY) all posted solid earnings reports last week, and their shares have risen so far this year. What happens to BIDU stock if and when investors’ views on China deteriorate?
The response by Baidu stock over the last two sessions is not an overreaction, or a panic, or a case of investors not paying attention. There have been real concerns about BIDU stock for some time now, and those concerns seem supported by both its Q1 results and its Q2 guidance. So it’s not surprising that Baidu stock has fallen so hard. And it wouldn’t be a surprise if BIDU keeps falling.
As of this writing, Vince Martin has no positions in any securities mentioned.