Baidu Earnings Beat Q3 FY 2015 Estimates, Shares Surge

  • Baidu has delivered healthy Q3 2015 results that have managed to top expectations.
  • The company's top line grew by a healthy clip while its bottom line showed anemic growth.
  • Baidu's margin pressure is likely to continue for a few more years.
  • This fact has, however, already been priced into the shares which remain a good long-term investment.

Chinese search giant Baidu (NASDAQ:BIDU) has reported third quarter fiscal 2015 earnings that managed to beat consensus estimates. Baidu reported revenue of RMB18.38 billion ($2.892 billion), good for 35.9% Y/.Y growth, as well as net income of RMB2.841 billion ($447.0 million), or non-GAAP EPS of RMB9.07 ($1.43), represented a large 26.7% Y/Y drop. Baidu’s revenue was in-line with estimates while the bottom line beat estimates by $0.03. On a GAAP basis, Baidu’s EPS clocked in at RMB7.92 ($1.25).

Baidu shares jumped 6.8% in after-hours trading. The shares are down 25.9% YTD.

Baidu’s Operational Highlights

  • Mobile Search Monthly Active Users (MAUs) surged 26% to 643 million.
  • Gross Merchandise Value(GMV) of Baidu’s O2O ventures namely Qunar, Baidu Nuomi and Baidu Takeout Delivery clocked in at RMB60.2 billion ($9.5 billion), a hefty 119% increase.
  • Baidu Wallet Activated accounts grew 520% to reach 45 million.

Baidu provided fourth quarter outlook as follows:

  • Revenue in the range of RMB18.200 billion ($2.864 billion) to RMB18.750 billion ($2.950 billion), which represents a 29.5% to 33.4% Y/Y increase.

Margin Pressure

The biggest takeaway from Baidu’s latest earnings report was that the company’s bottom line was increasingly coming under pressure due to mounting costs. Baidu’s operating margin dropped from 29% a year ago to 13.67% during the last quarter, a huge 1533 basis point decrease. I had discussed this in my Baidu earnings preview where I said that Baidu’s margin pressure was set to continue over the next couple of years due to the company’s heavy investments in 020 ventures. Baidu’s operating expenses grew 65.3% Y/Y, almost double the company’s top line growth. Of particular concern was Baidu’s SG&A expenses that jumped 111% Y/Y due to selling expenses associated with O20.

Baidu’s O20 (Online-to-Offline) ventures represent a merger between modern ecommerce and the traditional retail experience. This is a new online selling concept pioneered by Baidu and other Chinese online companies. Baidu’s O20 GGMV jumped 119% to $9.5 billion. But the bad part is that Baidu does not take a cut from the huge amount of O20 business it handles. During the previous earnings call, Baidu had this to say about its plans to monetize 020:

They're all growing very, very fast and together with our peers and competitors, we are educating the Chinese consumers the better way to order services. So eventually, we will be able to take a cut, a sizeable cut from that, but whether that's three-year or five-year, it's really hard to tell at this point.

Baidu said that the penetration of 020 was still in the low single digits, so it’s possible the company wants to first get a proper foothold in the new market before it can begin taking a cut. But with the segment growing so rapidly, investors can expect that 020 ventures will continue pressuring Baidu’s margins for a couple more years.

Baidu’s core search business, however, remains in the pink of health. Baidu is actually more dominant in China than Alphabet Inc-C (NASDAQ:GOOG) is in the U.S.--Baidu has an 85% share of search revenue in China compared to 65% for Google in the U.S. The pessimism surrounding the company and other Chinese tech companies has a lot to do with the Chinese stock market debacle. But it appears as if the market expects a hard landing for Baidu and other Chinese companies whereas economic data shows that a soft landing is more likely. China’s economy is projected to grow above 6% during the second half of the current quarter, which suggests that the pessimism about the country’s growth trajectory is overdone. The strong performance by U.S. companies such as Apple (NASDAQ:AAPL) in China is helping to assuage investor fears. Apple saw its sales in China, the company’s second largest geographical revenue segment, grow by 99% and far exceeding expectations.

Takeaway

The market seems to have accepted that Baidu’s margin woes are not about to slow down any time soon. The dark cloud that hung over Chinese companies also seems to be lifting. Baidu shares trade at a forward PE of 25, which actually looks cheap when you consider the company expects to grow earnings at 24% CAGR over the next five years. Baidu shares are a good investment for the long haul.

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