A Closer Look At Baidu’s Operating Cost Management

by Trefis Team
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Like most internet companies, Baidu (NASDAQ:BIDU) has been a high-growth stock this year. Baidu’s stock price consistently rose from $165 at the beginning of the year to $270 in October, before falling to $235 currently. The company has reported strong revenue growth in recent quarters, complemented by limiting growth in operating expenses. We have a $195 price estimate for Baidu, which is around 15% below the current market price. In this article we take a look at how efficiently Baidu has managed its operating expenses this year, and areas in which the company is expected to continue to invest in order to drive revenues and profits.

See our complete analysis for Baidu

A Brief Summary Of Baidu’s Operating Costs

In recent years, Baidu has invested heavily in its smaller (and faster-growing) segments, in order to fuel growth. These investments include 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. As the company has matured and gained customers, it has reduced expenditures on acquiring traffic. Through the year, Baidu’s traffic acquisition costs have declined 8% to just over RMB 7 billion ($1.1 billion).

In addition, Baidu managed to reduce its selling, general and administrative (SG&A) expenses by transitioning to a distribution model than a direct sales model, thereby reducing total headcount. This should help keep SG&A expenses low in the long run.

Comparatively, Baidu has made large expenditures to acquire premium copyrighted movies and television shows. The company has also produced original content exclusive to its platforms and affiliated third party platforms. As a result, content acquisition has become the largest individual cost this year, up 82% on a y-o-y basis, as shown above.

The other area where Baidu has continued to spend is research and development, which primarily includes personnel-related costs for the company’s research labs and facilities in China and California. The company has set up high-end research labs that work on machine learning, artificial intelligence, and has implementations across future high-growth industries ranging from self-driving cars, Big Data, language processing and deep learning. Out of a total of 46,000 Baidu employees, there were nearly 20,000 employees working in its R&D facilities by the end of last year. R&D expenses are expected to remain high in the long run.

Strong Operating Metrics Help Drive Performance

Baidu has reported a strong revenue growth this year, with revenues growing by high teens through the year. However, as shown above, total operating expenses (including cost of revenues) increased by only around 13%. Baidu’s resulting operating profit (GAAP) was up nearly 40% y-o-y to RMB 10.9 billion ($1.6 billion).

Baidu’s adjusted EBITDA also increased 38% on a year-over-year basis to RMB 16.5 billion ($2.4 billion) through the first three quarters of the year. As a result, its EBITDA margins expanded by over 4 percentage points to nearly 27%. Lower taxes and gains due to the disposal of Baidu Deliveries further drove the company’s net income and earnings per ADS. For the first three quarters, Baidu’s net income and diluted earnings per ADS nearly doubled, as shown in the table above.

Baidu To End Year On A High Note

For the full year, we forecast the company to register around 20% growth in revenues, driven by a strong performance from its non-core businesses, including iQiyi and transaction services. Disciplined expense management has led the company’s margins to expand through the year – a trend expected to continue in future quarters as well.

In addition, the company expects to continue to invest in R&D for potential growth areas such as mobile and AI-related ventures. Despite the increase in R&D and content acquisition costs, we expect Baidu to continue to improve its operating efficiency by limited growth in SG&A expenses, which should help the company report healthier margins.

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