Revenue Per Customer In Focus As Baidu Prepares To Release Q3 Earnings
Last quarter, Baidu(NASDAQ: BIDU) got much kudos from analysts for coming out with superlative second quarter results. [1]. Baidu will release its third quarter earnings report on October 29th after market close. In this article we reflect on how it may differ from the Q2 results.
Our valuation of the Baidu stock is at $225 a share, as opposed to market price of $220.
See our complete analysis of Baidu here
Whats Driving The Revenue
Online marketing revenues constituted ~99% of Baidu’s revenues in Q2 2014. It increased 57% in Q2 2014 when compared to Q2 2013. This helped it increase revenues 58.5% in comparing these two quarters, leading to an adjusted EBITDA increase of 29.3% for the same period. Profit margins did not keep pace with revenue growth as SG&A (Selling, General and Administrative) and R&D (Research and Development) expenses almost doubled between these two quarters.
In Q2 2014, average revenue per online marketing customer was 50.3% higher than its corresponding figure in Q2 2013. This increase is what has led to revenue growth as the increase in number of customers was absymal in comparison. It increased only 4.3% between the second quarters of 2013 and 2014. The low rate of increase in the number of customers was the consequence of the company tightening its criteria in terms of customers.
During the second quarter earnings call, the company’s CEO had suggested that most of this selectivity in customer acquisition was over and that customer acquisition should pick up going ahead. He also put in place a disclaimer that this was contingent on the market conditions and the capacity of the company. [1] We look forward to a greater share of revenue growth being driven by increase in the rate of growth of the number of customers, than through increase in average revenue per customer.
That said, we expect the average revenue per customer to continue its high growth rate based on the management’s commentary that there is untapped revenue potential among existing customers. It requires only the provision of necessary products and customer education about these to unlock. According to the CEO, this has been the situation for many years and is likely to persist going ahead, ensuring steady growth of revenue per customer. [1]
The management has given a revenue guidance of $2.16-2.22 billion for the third quarter, representing a 51%-55% year-on-year increase. The analyst’s consensus estimate at Businessweek.com stands at $2.20 billion. Last year, in going from Q2 to Q3, the revenues increased 25%, from $1.2 billion to $1.5 billion. [2] The Q2 revenue this year was $1.93 billion. Given the seasonality and our bullishness on the improvements in the drivers of revenue, we believe the revenue this quarter could beat the analysts estimate by a neat margin.
Whats Driving The Costs
The main component of Baidu’s expense structure is Traffic Acquisition Costs (TAC). These are the costs related to sourcing and managing internet traffic through Baidu’s search engine and network. In Q2 2014, they were 12.7% of revenues, which represents a ~1% increase year on year. The increase was explained by the CFO of the company as being on account of the increased contribution from the contextual and mobile services. Promotional activity associated with one of Baidu’s websites (Hao123), which is an online listings directory that is also the fifteenth most popular website in the world, also added to these costs. We expect these costs to remain the same as a percent of revenues, or show a very small increase, in the Q3 results. This is because we don’t see any one-time expenses of this type either in the second quarter or the third. [1]
The other major costs in the second quarter were SG&A and R&D expenses. SG&A expenses nearly doubled in Q2 on a year on year basis, to reach $346 billion. This was on account of the increase in promotional activity for mobile products. In the earnings call, the CFO identified three major sources of selling expenses. These are pre-installation, branding and promotions. Pre-installation costs refer to the marketing spend required to get users to install and use Baidu products. These are expected to drop as user adoption levels and familiarity with the products improve. However, on account of the need to increase user adoption of other Baidu products and services, promotional and branding costs are expected to continue to weigh on the earnings. [1]
R&D costs increased ~85% year-on-year in Q2 2014, on account of increase in the number of personnel employed. This increase is expected to continue at similar levels since Baidu has launched a host of new initiatives about which we have written in various articles earlier. (See Baidu’s New Moves, Weekly Chinese Internet Notes and Baidu-BMW Driverless Car Deal). Two smaller sources of costs, bandwidth costs and depreciation costs have gone down year-on-year in 2014, most likely due to the expanding revenue leading to economies of scale.
EPS Expectations
Businessweek analysts consensus estimate for Baidu’s earnings in Q3 2014 stands at $1.67, down from the reported EPS of $1.73 in Q2 2014. ((ref: 4))
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Notes:- Baidu’s Q2 2014 Earnings Call Transcript, seekingalpha.com [↩] [↩] [↩] [↩] [↩]
- Baidu Page At Businessweek [↩]