EARNINGS PREVIEW
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Baidu

After a crisis-filled second quarter, online search giant Baidu looks to better days ahead

PUBLISHED : Thursday, 28 July, 2016, 8:19pm
UPDATED : Saturday, 30 July, 2016, 8:15am

For Baidu chief executive Robin Li Yanhong, the past three months may have been his most trying time in business as the threat of bankruptcy and ruin loomed for the company he founded 16 years ago.

Nasdaq-listed Baidu was ordered by government regulators in May to strictly limit advertising per page and clean up its medical-related paid-search business, following public outrage over the death of 21-year-old computer science student Wei Zexi linked to a cancer treatment he searched online.

In an internal memo, Li rallied Baidu staff to help change the company’s culture and do the right thing.

“The management and employees’ obsession with KPI (key performance index) has twisted our values ... and distanced ourselves from users,” Li said at the time . “If we lose the support of users, we lose hold of our values, and Baidu will truly go bankrupt in just 30 days.”

Baidu, which has a more than 80 per cent share of China’s online search market, last month lowered its second-quarter earnings guidance by 10 to 12 per cent, after more than half of its medical customers temporarily cut or delayed spending on its platform.

Despite that setback, analysts expected the Beijing-based company to turn certain levers that may mitigate the impact of tighter regulation on its online advertising business.

“We are aware that clean-up of Baidu’s medical advertising, which accounts for roughly 25 per cent of its search revenue based on our estimate, will impact near-term core search revenue growth,” Jefferies equity analyst Karen Chan said in a report.

“We expect the impact to be more front-end loaded in the second and third quarters this year, beyond which high-quality health care advertisers should redeploy delayed ad spending once regulatory requirement is satisfied.”

Chan pointed out that “search remains as the most cost-effective online marketing channel”.

Jefferies, which has maintained a buy rating on Baidu shares, joined other analyst firms in revising the forecast for Baidu’s second-quarter earnings. It predicted Baidu to post revenue of 18.20 billion yuan (HK$21.161 billion), which is 9.3 per cent lower than the market’s consensus estimate of 20.08 billion yuan revenue in the same period.

Baidu projected its second-quarter revenue to be in the range of 18.10 billion yuan to 18.20 billion yuan, compared with its previously stated 20.11 billion yuan to 20.60 billion yuan range.

Li said last month a significant portion of Baidu’s revenue was sacrificed under that adjustment, but assured that it has taken steps “to further bolster a healthy, safe and trustworthy online and offline ecosystem”.

"The challenges Baidu faced in the second quarter served as a healthy reminder to stay focused on the key drivers of growth, sustainability and leadership: delivering the best user experience and staying at the forefront of technology," Li said on Friday.

"Baidu will rise to new heights, as long as we maintain the trust and loyalty of our users and continue to be at the forefront of innovation. This may mean doing the hard things, but the right things, for which there is no compromise."

Jefferies’ Chan said “higher cost per click [advertising] from intensifying bidding activities, adjustment in the bidding strategy of small and medium-sized enterprise advertisers, more contextual ad inventories through Baidu Union, and online-to-offline (O2O) advertiser uptake may mitigate mid- to long-term revenue impact” for Baidu.

Baidu Union is the programme through which the company expands online distribution of the customers’ sponsored links or advertisements. Baidu makes payments to Baidu Union members for acquisition of traffic from these clients’ own internet properties.

“Our checks also suggested a stable click-through rate, given that top four search results generally account for 70 to 80 per cent of total clicks per page,” Chan said.

Click-through rate is a metric referring to the ratio of users who click on a specific link to the total number of users viewing a page or advertisement. It is a common measurement for the performance of an online advertising campaign.

According to Baidu, it had about 594,000 active online marketing customers in the second quarter. The average revenue per online marketing customer was 28,000 yuan.

Tsang Chi, HSBC’s head of Asia-Pacific internet research, said in a report that medical advertising for Baidu is expected to improve in the second half of this year.

“We expect margins to improve as O2O spending rationalises this year,” Tsang said.

O2O activities of Baidu and its Chinese internet peers, Alibaba Group and Tencent Holdings, are centred on connecting their users with local services. Alibaba is the owner of the South China Morning Post.

Baidu last year committed a three-year, US$3.2 billion investment to boost the capabilities of its Nuomi O2O platform, in which goods and services are booked online and fulfilled offline.

According to HSBC, the O2O market in mainland China is worth close to 10 trillion yuan.

Li pointed out that "Baidu's value proposition... and ambition for the future remains undiminished", while experiencing what he described as "short-term hiccups".

He said the Baidu Brain artificial intelligence infrastructure now supports all of the company's product lines. Baidu Brain is credited with helping improve search as well as the accuracy of voice and image recognition.

"Baidu Brain not only benefits our core search business, it also opens up new opportunities in areas such as financial services, where we see great potential in education loans, online banking and online insurance," Li said.

He added that the company's search and map applications have become "powerful first-stop gateways, where users come to consume content, inquire and make decisions and transact".

"Search, maps and Nuomi continue to cross-leverage and mutually share content and services. Search and map -- with around 670 million monthly active users and 340 million MAUs, respectively -- continue to grow as clear leaders in their categories," he said.