Baidu: A Stock to Avoid These Days

Baidu Inc. (BIDU) is one of the largest Chinese tech companies, often referred to amongst investors as “the Google of China” due to its dominance in the search space.

Baidu’s shares have suffered significantly over the past year, starting with the Chinese government’s crackdown on big tech last year, which raised investor concerns, followed by the ongoing correction tech stocks are currently undergoing.

In my view, while Baidu appears to have become cheaper lately, I remain concerned regarding the company’s long-term prospects, iQIYI’s profitability, and lack of adequate capital returns to shareholders. For this reason, I am neutral on the stock.

Profitability Risks Related to iQIYI

Baidu’s Q3-2021 results were rather mixed. The company reported a $2.57 billion GAAP loss in the quarter, but a $790 million non-GAAP profit, suggesting a decrease of 27% year-over-year and a 5% decrease quarter-over-quarter.

GAAP losses were ugly, primarily driven by Baidu’s investments. The company recorded $3.4 billion in losses related to its long-term investments. While the exact way the company derives these numbers can be rather ambiguous (a risk to take note of when investing in even the best Chinese stocks, in general,) Baidu’s iQIYI (IQ) equity stake seems to have had a major impact on GAAP earnings during the period.

Baidu controls iQIYI, owning around 58.8% of its shares. iQIYI’s share decline from around $15.5/share (worth around $12.4 billion) at the end of Q2, to $8.03/share (worth around $6.4 billion) at the end of Q3, suggests a $6 billion decline, and with Baidu’s ~59% stake we can say that the losses were ~$3.5 billion.

In my view, iQIYI’s consistently ugly results will continue weighing on Baidu’s results for years to come. iQIYI has failed to grow its subscriber base meaningfully over the past couple of years, resulting in stagnated revenues. In the meantime, management continues to spend tons of cash on content and tech investments (apparently without much success), resulting in negative net margins for years now.

Without any catalysts pointing towards this case reversing or improving in the short to medium term, I forecast that Baidu’s iQIYI equity stake will continue deteriorating the company’s balance sheet going forward.

Wall Street’s Take

Turning to Wall Street, Baidu has a Strong Buy consensus rating, based on ten Buys assigned in the past three months. At $257.90, the average Baidu stock forecast suggests 70.5% upside potential.

Conclusion 

Despite analysts’ optimistic upside anticipation, I remain wary of Baidu’s investment case. As is the case with other China-based companies, anything from Baidu’s earnings reporting, to medium-term strategy, to the company’s plan on returning cash to shareholders remains unclear.

Based on expected EPS of $8.18 for the year, Baidu’s P/E appears to be standing at around 18.5 at the stock’s current levels. In my view, considering the overall risks surrounding the stock, Baidu’s valuation remains rich, despite the recent sell-off relative to many rapidly growing and reliable American companies in the space with clearer prospects ahead.

Finally, I find the company’s iQIYI equity stake a bad asset, which will likely erode Baidu’s shareholder value further. Consequently, I believe that Baidu is a stock to avoid in the present moment.

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