This article was written by Mingyue Liu, a financial analyst at I Know First

Stock Price BIDU: An Empire Built On Three Pillars

“Artificial intelligence will reach human levels by around 2029. Follow that out further to, say, 2045, we will have multiplied the intelligence, the human biological machine intelligence of our civilization a billion-fold.” (Ray Kurzweil)

Summary:

Search Engine: Transition to newsfeed

iQiyi: Ready to cash in previous content investment

AI: Refocus on the future

Search Engine

Baidu was founded in 2000 and started as a search engine provider and is now the largest Chinese search engine provider. It is one of the largest internet company around the world.

Besides the basic Baidu’s web search, which allows users to locate information through search queries, Baidu offers a wide spectrum of service products. Products include Baidu Post Bar, a social media platform that attracts users through topics of common interest; Baidu Image Search, which enables users to search for images on the internet; Baidu WenKu, an online document sharing platform; Baidu Knows, which provides users with a query-based searchable community to share knowledge and experiences; Baidu Encyclopedia, which is similar to Wikipedia; Hao123.com, a website directory navigation site.

Some of Baidu’s search business products

Search business used to be the star of the company, and Baidu still is the indisputable leader in Chinese search engine market, representing 80% of mobile page views. However, due to the rapid change of search behavior and the most recent healthcare scandal in mid-2016, the company is faced with strain in its core business.

Knocked off the course In April 2016, Wei zexi, a 21-year-old, died after receiving treatment from an unqualified hospital, which was promoted by Baidu. People condemned Baidu for his death, and Chinese regulators imposed restrictions on Baidu’s advertisement. Baidu’s 2Q17 net income was down by 34.1%, partly dragged by the scandal. Baidu has been making efforts to comply with the regulations, identity authentication of advisors has been finished by January. Further, Baidu has also applied it to companies beyond healthcare industry. The market responded positively to such efforts. Sales, especially from healthcare categories, have been recovering since 4Q16.

for last two quarters. Search services include keyword-based marketing services targeted at and triggered by internet users’ search queries, which mainly include pay-for-performance (P4P) services and other online marketing services.

Coming back with advantageous newsfeed service Newsfeed is the promising direction of online advertising, which inspired in-feed advertising. It is different from traditional search in that newsfeed gives content recommendation based on individual browse and search history.

Robin Li, founder and CEO of Baidu, delivered a speech at the beginning of 2017, addressing that Baidu’s next focus would be providing newsfeed products, which signed the transition from “find specific information” model to “found by the information” model. Baidu is now integrating newsfeed into its search engine business. The company is playing aggressively in this field, willing to share up to 100% of ad revenues within articles. What’s more, the price of Baidu’s in-feed ads is significantly lower than other advertising price. According to Baidu, they are currently focusing only on improving user experience but not monetization of the service. We can tell from the management that Baidu is contemplating longer term means of broadening forms of search, and seeking to monetize them appropriately.

Baidu has only begun to make clear strategy from 2016, but the company is well positioned in the new trend. With its basket of search products, Baidu has 3.5 billion daily page views. The company owns more information regarding customer preference than most of peers. Thanks to its progress in AI, Baidu can provide precise in-feed recommendations to its users, proved by the positive feedback from the market. As the expansion of newsfeed usage, there is great potential in revenue growth from advertisement inventory.

According to Baidu, newsfeed is an increment rather than a substitute to traditional search business, without noticeable cannibalism. Newsfeed is expected to more than offset the decreasing O2O spending, which is the traditional source of revenues from search business.

In addition, Baidu has historically experienced seasonality, with 2Q representing the highest revenues. Because of the summer campaign of companies, I expect Baidu to report better operating outcomes for this quarter. Furthermore, small and medium enterprises (SME) are thriving, thanks to the stable growth of Chinese economy. The ROI-sensitive SME are expected to be the new source of in-feed ad revenues.

Positive outlook for the core business Newsfeed is currently at the early stage of monetization. With the integration of AI, which is the new emphasis of the company, Baidu’s can offer more customized in-feed information to its user, which will power the further growth of the search business.

According to Market Line, Chinese mobile apps market is expected to grow at a CAGR of 8.5% during 2016-21 periods to reach a value of $109.3 billion by the end of 2021. Baidu offers a broad range of mobile products, and is well-positioned to cash in this growth.

iQiyi

iQiyi is currently the largest online video site in China, with a content library that includes licensed movies, television series, cartoons, variety shows and other programs. It was founded in 2010 by the joint capital of Baidu and Providence Equity Partners, an American private equity investment firm focused on media, communications, education and information investments. At the end of 2012, Baidu bought Providence’s stake and took 100% ownership of iQiyi. In May 2013, Baidu purchased the online video business of PPStream Inc, another Chinese online video service provider, and made it the subsidiary of iQiyi.

According to iReasearch, iQiyi is currently leading online video market, accounting for 36% of mobile video time spent market share, following by Tencent and Youku-Tudou, which contribute to 25% and 23%, respectively. The leading provider of online consumer insights also unveiled that iQiyi enjoys a monthly-active-user base of 490 million, with 45 million paid subscribers as of FY 2016. The number of subscribers has surged by 350% for the last year, and the market expected this trend to keep on going. According to a research released by J.P. Morgan on May 11, paid subscribers are estimated to reach 182 million by 2010, indicating a CAGR of 42%. iQiyi accounted for roughly 16% of 2016 revenues.

It is noticeable that despite its booming customer base, iQiyi consistently reports operating losses. This is largely due to the significant content investments made by iQiyi, in order to improve its service. The company has signed in late April a content licensing agreement with Netflix, one of the world’s leading Internet television networks, for a subset of Netflix original series such as Black Mirror. The contract is expected to take place in 2H17. iQiyi has also bought the airing right of the second season of a popular Chinese drama Nirvana in Fire, whose first season gained a total of 5.5 billion plays. At the same time, iQiyi also launched its in-house drama. It has introduced the second season of Candle in the Tomb, which attained over 4.3 billion plays. Looking forward, iQiyi will for sure explore producing more in-house series, for the flexibility of production and better return on investment (ROI).

The exclusive broadcasting rights and persistent zeal about its in-house drama would bolster the ramp-up of iQiyi subscription, turning it profitable and pushing its revenues.

All in AI

Baidu was the first one in BAT, the big three in Chinese AI market including Baidu, Alibaba, and Tencent, to launch into this field. The company is currently on track of the transition to become a technology company.

Baidu is now leading Chinese market in terms of AI achievements, which has been elaborated in our previously published article China AI: A Latecomer In AI Industry Seeking To Surpass Predecessors.

The company has reached an updated high accuracy in picture and voice recognition of 99.77% and 97%, respectively. Baidu recently hit the headline as 2017 Baidu Create Conference was held on July 5, in Beijing. The successful test drive of Baidu’s driver-less vehicle indicated the first stage’s success of Apollo, a lofty ambition of Baidu to provide an “open, complete, and safe platform” to automobile industry. On July 18, the company announced the partnership with Microsoft (MSFT), according to which MSFT will offer cloud infrastructure services via Azure for customers outside China looking to adopt Apollo. This announcement has push MSFT to an all-time high, indicating market’s positive attitude towards this project. Also, Baidu is dedicated to push AI into households. It has been working on building partnership with local and foreign entities, in order to launch its DuerOS, a voice-based operating system that was designed to be integrated with household appliances.

Conclusion:

My bullish outlook towards BIDU is supported by catalysts covering the short-, mid-, and long-term operations. For the short run, search engine service is expected to recover with the introduction , development and monetization of newsfeed. iQiyi is ready to cash in, powered by the partnership with Netflix, the development of in-house drama, and the striction of copyright infringement. For the long run, heavy investments in AI would pay off. I believe the first mover advantage and significant progress would award BIDU a perfect position in the future market.

My expectation for Baidu resonates with I Know First forecast based on AI.

Past I Know First success with BIDU

On July 10 2016, I Know First published bullish forecast on BIDU. Since then, the stock price has increased by over 20.89%, showing another success of I Know First algorithm in forecasting stock movement.

I Know First Algorithm Heatmap Explanation