The Motley Fool

Why Baidu Inc Might Be a Great Long-Term Investment

An assailant recently doused Baidu Inc (NASDAQ:BIDU) CEO Robin Li with water at an Artificial Intelligence (AI) conference. Li might not be alone underwater. Shares of the Chinese search engine are down nearly 30% year-to-date.

Once regarded as one of China’s big three “BAT stocks” along with Alibaba Group (NYSE:BABA) and Tencent Holdings Limited (SEHK:700), Baidu has recently lagged and its market cap is now around a tenth of Alibaba’s and Tencent’s. What has hindered it has been its failure to adjust to the mobile internet while super-apps such as WeChat (with search features) have hurt Baidu’s core business.

Furthermore, Baidu’s transition from just a search engine to an AI business has been rough. Because its AI efforts, such as the Apollo autonomous driving system or smart devices, have yet to produce significant cash flows, tangible financial results from these new areas of investment haven’t been forthcoming.

Near-term softness

In the near term, regulatory headwinds in games and healthcare, a weak Chinese economy, and an excess of ad inventory have all led to the former high-flying Baidu to crash closer to earth.

Due to weaker economic growth, Chinese companies have trimmed their advertising spend. As a result of the weak advertising market, Baidu reported a terrible first quarter, with its first loss in over 13 years.

Meanwhile, near term revenue growth is close to zero. For the second quarter, the company expects sales of RMB 25.1 billion to RMB 26.6 billion, or a decrease of 3% to an increase of 2% versus the same quarter last year. In terms of market expectations, Wall Street expected growth of around 14% year-on-year for the period.

Reasons to be optimistic

While Baidu has suffered some near-term problems, there are reasons to be optimistic in the longer term. First, Alphabet‘s (NASDAQ:GOOGL) Google won’t challenge Baidu anytime soon as Google recently revealed that it has terminated its censored search engine originally designed for China. With Google out of the running, Baidu’s position as China’s leading search engine seems secure.

Next, Baidu has a share buyback programme of up to US$1 billion effective 1 July 2020. Management has dry powder for more buybacks if it decides to go down that route. As of the end of March 2019, Baidu had cash, cash equivalents, restricted cash and short-term investments of RMB 125.7 billion (US$18.7 billion) when excluding iQiYi.

Baidu is also making progress with its AI smart-speaker system. As of June, Baidu’s DuerOS has been installed on over 400 million devices, giving Baidu market share of 16% globally. Due to its growth, Baidu’s global market share is only behind Google (17%) and (NASDAQ:AMZN) (27%). If management executes, many analysts believe Baidu’s AI smart-speaker business could one day be worth billions.

Lastly, many analysts regard Baidu as the current leader among Chinese tech companies in autonomous driving. If successful, Baidu’s Apollo autonomous driving system could potentially replace search as the main driver of the company’s cash flows. Also, any sort of spin-off or capital raise of its autonomous driving system at a higher-than-expected valuation could be a catalyst that unlocks value.

Foolish takeaway

Due to the weak Chinese advertising market and its transition to AI from purely search, Baidu has faced some near- and medium-term problems. However, given its leading position in search, its strong balance sheet, and its AI efforts, I believe Baidu is promising and has the potential to be a great investment over the long term.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Jay Yao doesn’t own shares in any companies mentioned.