Baidu Stock Will Remain Under Pressure Going Into Q4 Earnings

  • Baidu is due to report Q4 2015 earnings on Feb. 10th 2016 after market close.
  • Baidu's heavy investments in O2O ventures are expected to continue pressuring the company's margins and shrinking its earnings.
  • Does Baidu stock has any potential catalysts that can give the stock some forward momentum?

Leading Chinese Internet search company Baidu (NASDAQ:BIDU) is due to report q4 2015 earnings on Feb. 10th 2016 after market close. During its third quarter earnings call, Baidu said that it expects fourth quarter revenue to be in the range of RMB18.2B-RMB18.75B ($2.864B-$2.950B) which represents year-over-year growth of 29.5%-33.4%. Wall Street sees the company reporting revenue of $2.806B with EPS of $0.80, representing 26.6% and -45% year-over-year growth, respectively. If these estimates turn out to be accurate, then the fourth quarter will extend Baidu’s long streak of shrinking earnings.

Baidu has failed to meet Wall Street's earnings estimates in three out of the last four quarters, the last quarter being the exception when it exceeded estimates.

Baidu Earnings Surprise History

Fiscal
Quarter End
Date
Reported
Earnings
Per Share
Consensus
EPS* Forecast
%
Surprise
Sep2015 10/29/2015 1.25 1.2 4.17
Jun2015 07/27/2015 1.64 1.8 -8.89
Mar2015 04/29/2015 1.09 1.13 -3.54
Dec2014 02/11/2015 1.45 1.6 -9.37

Source: NASDAQ

Shrinking Profits

Baidu stock has come under a lot of pressure lately, partly due to the turmoil in the Chinese equity markets and partly due to the company’s shrinking profits, courtesy of its O2O ventures. Baidu has been investing heavily in O2O, or Online-to-Offline, businesses as it seeks to expand its footprint beyond its core search business. Baidu stock is down 23% YTD and 33% over the past 12 months.
BIDU stock chart

Source: Baidu Stock Price Data by amigobulls.com

During Q3 2015, Baidu introduced a new revenue segment called ‘‘Transactional Services’’ which mainly comprises of its O2O businesses. Baidu’s growing line of O2O ventures include Baidu Takeout Delivery, Baidu Nuomi, and iQiyi. These businesses are expanding at a rapid clip: Baidu Takeout Delivery expanded its GMV (Gross Merchandise Volume) 12-fold year-over-year while Baidu Nuomi saw its GMV increase 475%. Baidu reported that its O2O business had combined GMV of $6.5B during the quarter, up 119% Y/Y.

Unfortunately, this rapid growth is coming at a steep price. During the third quarter, Baidu’s SG&A expenses grew 81% to $627.4M, more than twice top line growth of 35.9%. This large line item now gobbles up 22% of Baidu’s revenue.

Under normal circumstances, the rapid growth of O2O segment would have given investors some cheer. But the big problem here is that investors view Baidu’s O2O ventures as little more than speculative plays because the company does not as of yet make any money from the huge volume of O2O business it’s handling. But that’s not all. Baidu does not see itself making any money from its O2O businesses in the near future. You can tell as much from the company’s comments during its last earnings call:

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 announced that it intends to invest another ~$3.2B in its O2O ventures over the next three years. Wall Street sees Baidu’s O2O investments weighing down heavily on the company’s profits in the first half of 2016. During Q3 2015, Baidu’s gross margin shrunk 150 basis points sequentially and 320 basis points year-over-year to 59.3%. Baidu said that Transaction Services had an impact of negative 32 percentage points on the company’s overall non-GAAP gross margins. Now that’s really huge. Meanwhile, Baidu’s earnings dropped 26.7%. The fourth quarter is not likely to be any different.

There have been rumors that Baidu might decide to borrow a leaf from its U.S. search counterpart Alphabet Inc-C (NASDAQ:GOOG) and spinoff its nine non-search businesses into a separate business unit. Google recently split its non-core businesses from its core search and ads business, though in Google’s case it did not completely spin the businesses off. Although Baidu has shot down the speculations, investors will no doubt be eager to see this happening sooner rather than later in order to give the company’s pressured bottom line a much-needed break.

Baidu recently spunoff its stake in Qunar (NASDAQ:QUNR), a leading Chinese online travel company, after it sold it to Ctrip (NASDAQ:CTRP), another OTA. Qunar has been pulling down Baidu’s profits due to the highly competitive nature of online travel in China. Baidu had indicated that Qunar will have an impact of negative 4 percentage points on the company’s gross margins in the fourth quarter. Baidu did not sell its Qunar stake outright to Ctrip, but rather swapped it for a 25% stake in Ctrip. The deal appears to have been favorable to Baidu since it managed to sell its stake in Qunar at a healthy 36% premium, a no mean feat considering the ongoing volatility in the Chinese market. Although this move should help ease the margin pressure on Baidu’s bottom line a bit, it’s effect will likely be masked by the much larger negative effect of O2O.

Investor Takeaway

Baidu’s O2O ventures have been putting a lot of pressure on the company’s bottom line and shrinking its margins. Baidu remains committed to its O2O ventures over the long-term, so investors should not expect the margin pressure to ease anytime soon. If, however, Baidu does choose to spin off its unprofitable non-core businesses, then Baidu stock would likely receive a big boost. Right now the only major catalyst for Baidu stock appears to be its share buyback program.

The company recently authorized a $2B share buyback program, and could potentially do more since it has more than $11B cash and short-term securities on its balance sheet. A $2B buyback would lower Baidu’s outstanding shares by ~4%, which is not big enough to bolster its rapidly shrinking EPS. Baidu stock is likely to remain depressed until the company can grow its earnings again.

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