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One of Baidu’s most lucrative sources of advertising could be at risk after Chinese regulators launched an investigation into the search engine giant amid public outcry over the death of a student.

Shares of Baidu ( BIDU ) plummeted almost 8% on Monday, its biggest fall this year, after China’s internet watchdog announced a probe after the young man criticized the search engine for advertising the experimental cancer treatment that ultimately failed to cure his rare form of cancer. It’s a bad look for the company and investors should steer clear, especially given the uncertainty about the extent of any punishment – and its impact on earnings – that may follow the investigation. While the stock is down 5% for the year, at 24 times forward earnings it looks pricey compared to rival Alibaba ( BABA ), which trades at 23 times and has a stronger presence in new growth areas in China’s dot-com sector such as Internet finance and online-to-offline (O2O) commerce.

Analysts are divided on the outcome of the investigation and punishments that may be imposed on the company. Nomura’s Jialong Shi argues the public outrage triggered by the case could prompt regulators to “convict Baidu of wrongdoing at the end of its investigation and suggest certain punishments to appease the public.” It doesn’t help Baidu’s case that Beijing has adopted a tougher stance on consumer protection. Amendments to advertising laws last September clamped down on false or misleading advertisements and specifically prohibited the advertising of healthcare or pharmaceutical products under the disguise of health information programs or columns on radio, TV, printed media or the Internet.

A grey area for Baidu was that the advertisement for the experimental cancer therapy from a Beijing military hospital appeared as a sponsored link among search results. However, CICC analyst Peng Zou argues that sponsored links on the search engine are labeled as promotions in Chinese characters. Additionally, it would have been difficult for Baidu sales staff to assess the validity of claims made in the advertisement given the rapid pace of advancements in cancer cell treatments.

If Baidu is convicted, Nomura’s Shi says a minimal punishment could be a fine for violating certain regulations or misconduct as an ad publisher, which would be immaterial to Baidu no matter the size of the fine. However, a tougher response could see regulators slap a complete or partial ban on online healthcare advertising. The scenario could severely dent Baidu’s earnings given 20% to 30% of search advertising revenues are earned from the healthcare sector. Search advertising is the bread and butter of Baidu’s business and accounted for 94% of the company’s revenues in the March quarter. Although a ban on online healthcare advertising seems unlikely, says Shi, Baidu could be badly hurt by negative press coverage that tarnishes its image as a trustworthy and reliable search engine. “This would affect the performance of healthcare-related ads,” says the analyst, who has a neutral rating on Baidu with a $187 a share price target. Baidu shares currently trade at around $179 apiece.

Email: isabella.zhong@barrons.com

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