Baidu Earnings: Sustained Growth In Revenues, Margins Continue To Shrink

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Baidu (NASDAQ:BIDU) announced its Q1 2017 earnings on April 27, reporting a 7% year-over-year increase in net revenues to RMB 16.9 billion. [1] Baidu reported a 9% fall in operating profit to RMB 2 billion due to an increase in operating costs. Baidu’s total operating costs were up 9% to RMB 14.9 billion, with content acquisition costs (for iQiyi online video), traffic acquisition costs and bandwidth acquisition costs driving much of the growth. Moreover, the company’s net income was correspondingly lower than the prior year period and earnings per ADS was 14% down to RMB 4.63 per ADS for the quarter.

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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 iQiyi and transaction services segments witnessed over 70% revenue growth in 2015, which was slightly lower than the triple digit growth seen in the previous year. Although revenue growth slowed down for transaction services in 2016, revenues for iQiyi more than doubled to RMB 11.3 billion. The company has reported strong growth metrics in terms of gross merchandise value (GMV), the total number of Baidu Wallet users as well as monthly active users for Baidu Maps.

Despite strong growth metrics, Baidu 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] During the quarter, Netflix and Baidu signed an agreement which would allow Netflix to stream some of its programs in China pending regulatory approval. [4]

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 the March quarter was down around 16 percentage points on a y-o-y basis while the operating profit margin for iQiyi compressed by over 11 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 of these divisions to be be negative over the next few years.

Robust Guidance For Q2’17

Baidu’s management expects its June quarter revenues to be over 13% higher on a year-over-year basis to around RMB 20.7 billion. Strong growth is expected from the core business as well as smaller revenue streams including iQiyi and transaction services. [5] According to Reuters’ consensus estimates, Baidu’s net earnings per ADS could be over 40% higher on a y-o-y basis to RMB 9.34 as shown below. [6]

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Notes:
  1. Baidu Announces First Quarter 2017 Results, Baidu Press Release, April 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. Netflix enters China via licensing deal with top video streaming service iQiyi, Tech Crunch, April 2017 []
  5. Baidu Q1 2017 Earnings Call Transcript, Seeking Alpha, April 2017 []
  6. Reuters Analysis For Baidu, Reuters Analysis For Baidu, April 2017 []