Baidu Q2 15A – Chinese rocket

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Baidu is looking to create a Rocket Internet of China.

• Baidu is investing heavily in its e-commerce services and the platform that powers them to augment the slowing growth that is coming from its core businesses.
• Baidu reported difficult results and guidance as the slowdown in the Chinese economy and signs of stabilisation in mobile caused results and guidance to miss expectations.
• Q2 15A revenues / EPS were RMB16.6bn / RMB10.19 (per ADS) compared to consensus at RMB16.6bn / RMB10.76 (per ADS) which was slightly adrift of Q2 15A revenue guidance given in April 2015 which was RMB16.75bn.
• Revenues from mobile devices was 50% of the total which was the same as it was in Q1 15A.
• This is slightly worrying as mobile is growing much faster than fixed which implies that Baidu has lost some share during Q2 15A.
• The miss on EPS was primarily caused by increases in expenses from content costs at iQiyi and investments being made in Baidu online to offline strategy (O2O).
• O2O represents services that already exist but can be improved and made more efficient by running them online or on mobile. (Uber, mobile payments, eBay etc are all examples).
• The move into O2O brings Baidu into the core businesses of Tencent and Alibaba where competition will be fierce and margins lower.
• Baidu reported a 24% YoY growth in mobile users to 624m, 304m users of its mobile maps and 35m users of its mobile wallet.
• Guidance was disappointing with Q3 15E revenues forecast at RMB18.17bn – RMB18.58bn (midpoint RMB18.38bn) which missed consensus at RMB18.84 by 2.4%.
• The combination of the inevitable slowing of the Chinese economy and the early stage of Baidu’s mobile ecosystem looks to be behind the weaker than expected guidance.
• This is why I suspect that Baidu’s is branching out into O2O as e-commerce is already large and well established but with plenty of growth still left in the Chinese market.
• While this will drive revenues in the medium term, profitability is likely to suffer as O2O will have much lower gross margins than the 60% that Baidu currently enjoys on its search and other online services.
• In the short-term the theme is likely to remain heavy investments in O2O and falling margins before these investments begin to payoff.
• This combined with the slowing outlook for the core businesses creates enough uncertainty around Baidu to keep me cautious for now.