Baidu Earnings: Core Revenues Stumble, iQiyi & Transaction Services Shave Off Profits

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Baidu (NASDAQ:BIDU) announced its Q4 and full year earnings on February 23, reporting a 3% year-over-year fall in net revenues to RMB 18.2 billion. [1] However, excluding the impact of the Qunar division which Baidu sold off last year, the company observed roughly flat revenues over the year-ago period. Baidu’s total operating costs were up 6% to RMB 16 billion, with content acquisition costs (for iQiyi online video), traffic acquisition costs and bandwidth acquisition costs driving much of the growth. As a result, Baidu’s operating profit (GAAP) for the quarter was down 38% y-o-y to RMB 2.2 billion. Moreover, the company’s net income was significantly lower than the prior year period and earnings per ADS was 84% down to RMB 11.40 per ADS for the quarter.

bidu_q4_e1

Smaller Segments Drive Revenue Growth, Compress Margins

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Baidu has witnessed strong growth in two of its smaller revenue streams over the the last 2-3 years — its online video streaming platform iQiyi, which is similar to Netflix (NASDAQ:NFLX), and transaction services. Both segments witnessed over 70% revenue growth in 2015, which was slightly lower than the triple digit growth seen in the previous year. The company reported 23% growth in the gross merchandise value (GMV) for its transaction services segment to RMB 18.1 billion in the December quarter. Similarly, the total number of Baidu Wallet user accounts was up to 100 million users by the end of December, up from only about 53 million in the year-ago period. Furthermore, the total number of monthly active users (MAUs) for mobile maps rose to 341 million users, 23% higher than the previous year levels.

Similarly, Baidu’s iQiyi online video streaming has also grown at a rapid pace over the last couple of years. However, the company has operated its streaming video business as well as the transaction business at a loss over the past few years. In December 2015, there were reports suggesting that the company could spin off the iQiyi division. Earlier last year, a consortium of investors led by Baidu CEO Robin Li wanted to buy out the iQiyi business for $2.3 billion, but later dropped the bid after investors claimed that the price was too low. [2] More recently, Baidu announced that it has raised funding for the video streaming business, which should help it acquire more content and help the company focus on long-term growth. [3]

To fuel growth in the smaller revenue streams, Baidu has invested heavily in content acquisition costs, bandwidth costs for the video business and traffic acquisition costs for the transaction business, in addition to high marketing expenses for both. This has led to operating losses for both divisions over the last few years – a trend which was also observed in the most recent quarter. Baidu reported that the operating profit margin (non-GAAP) for the transaction services business in Q4 was down around 22 percentage points on a y-o-y basis while the operating profit margin for iQiyi compressed by over 9 percentage points through the quarter. These divisions are likely to be operating at a loss over next couple of years as well. As a result, we forecast the operating profits for both these divisions to be be negative over the next few years.

Growth In The First Half Of The Year Drives Full Year Results

Over the last two quarters, Baidu’s revenue growth for its core search services segment has been hindered by a revision in regulatory policy that drove down marketing revenues through the quarter. According to the latest Chinese laws, online ads and marketing practices for medical, pharmaceutical, and healthcare products and services on online platforms have to go through mandatory regulatory approvals. [4]

bidu_q4_e2

Net revenues for the full year were around 6% higher on a y-o-y basis to RMB 70.5 billion. Comparatively, higher operating expenses – primarily for content acquisition, bandwidth acquisition and marketing expenses led operating profit to fall by 14% to just over RMB 10 billion. As a result, the company-wide operating profit margin compressed by 360 basis points to 14%. The resulting earnings per ADS was down 67% to just under RMB 32 per ADS, as shown above.

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Notes:
  1. Baidu Announces Fourth Quarter 2016 Results, Baidu Press Release, February 2017 []
  2. Group Led by Baidu CEO Abandons Bid to Buy Out Video Unit, Wall Street Journal, July 2016 []
  3. Baidu’s iQiyi video service raises $1.53 billion, Tech Crunch, February 2017 []
  4. Chinese regulators restrict Baidu healthcare advertising, PM Live, May 2016 []