Why Baidu’s Declining Profit Trend Could Reverse This Year
Chinese internet giant Baidu (NASDAQ:BIDU) has been the dominant search engine in China, commanding an 80% market share in the search advertising business in the region. The explosive IT growth in China, complemented by consistently increasing internet penetration in recent years, has led display advertising and search services revenues to grow massively over the last decade or so. Search services is the largest division within Baidu, generating over 80% of the company’s net revenue in 2015. Over the last few years, Baidu has invested heavily in other businesses ranging from online video streaming (iQiyi) and transaction services, with a range of offerings such as online buying, and payments. These revenue streams have grown at a faster pace than the search business, and are expected to continue to drive top line growth for the company. We forecast search services revenues to grow at 13-15% annually in the coming years, while online video and transaction services combined could grow at 30-40% over the next few years.
On the other hand, the online video business is expected to drive a large portion of operating expenses in the coming years. Baidu’s online video business has operated at a loss since it started iQiyi in 2012. Large content acquisition costs, bandwidth costs and marketing expenses have resulted in negative operating profits in this division – a trend likely to continue in the near term. Content costs for iQiyi increased from about $140 million in 2013 to $600 million in 2014 to $1.3 billion in 2015, while both marketing expenses and bandwidth costs increased by over 80% in 2015. Similarly, the transaction services division also observed a massive hike in operating expenses over the last couple of years, primarily attributable to marketing costs and traffic acquisition costs in the same period. In the near term, we forecast Baidu’s full year operating expenses to increase by about 19% with search services operating expenses by almost $700 million to $4.6 billion.
Baidu’s operating profit margin stood at 19.7% in 2015, which was about 8 percentage points lower than the previous year levels. The company witnessed a similar drop in operating margin levels in the last 2-3 years. As mentioned earlier, the main reason for the fall in margins was the high costs associated with acquiring content, traffic and marketing costs. As these divisions mature, the year-over-year increases in operating expenses is likely to fall and its resulting operating profit margins should improve. [1]
Have more questions about Baidu? See link below:
- What Will Baidu’s Revenue And EBITDA Look Like In 5 Years?
- What’s Baidu’s Fundamental Value Based On Expected 2016 Results?
- How Valuable Are Search Services To Baidu’s Business?
- Here’s How Baidu Could Be Impacted By China’s New Rules For Online Search And Advertising
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- Baidu Q4 2015 Earnings Call Transcript, Seeking Alpha, February 2016 [↩]