Baidu's Struggle Amidst Multiple Pressures
Just like the previous quarter, Baidu.US's core performance in Q2 once again exceeded conservative expectations. The main highlight was the increase in operating profit margins due to cost optimization. In addition, for some leading institutions, macro pressures led them to lower their expectations for advertising revenue growth before the financial report, and Baidu's actual revenue performance slightly exceeded expectations.
However, in the post-earnings communication, the management expressed expectations that the performance in Q3 will continue to be under pressure. Although there is an active impact from the accelerated penetration of generative AI search content (which is not yet commercialized), they also acknowledged the pressures brought by the current macro environment, which is precisely the most fundamental reason for the recent surge in Chinese concept bombs.
The following text focuses on Baidu's fundamentals, so it only discusses Baidu's core performance.
Specifically:
1. Profits exceeded expectations: The Q2 profit beat was mainly due to staff reduction, which can also be seen from the 27% year-on-year decline in equity incentives, coupled with strict control over promotion expenses, offsetting part of the increased AI spending. Ultimately, Baidu's core R&D expenses decreased by 8% year-on-year, and sales and management expenses decreased by 11% year-on-year.
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2. Advertising faces a "double" pressure in the short term: Core advertising saw negative growth in Q2, with a year-on-year decline of 2%. The management attributed this to the proactive promotion of AI, as the proportion of search results provided by AI increased from 11% to 18% in Q2, but this part has not yet begun to be directly commercialized (expected to be considered in Q4). If the impact of AI is excluded, there is still positive growth, but the main driver was the e-commerce competition during the 618 period.
On the other hand, the management also mentioned macro pressures, which once again confirmed the market's most worrying point. In the context of weak consumption, offline small and medium-sized businesses are often the first to feel the pinch, which is a significant portion of Baidu's advertising customers.
Therefore, it is expected that in Q3, under the dual pressures of external macro and internal Gen-AI promotion, the decline in revenue will further expand. However, the management believes that in Q4, as AI search begins to be commercialized and the base becomes lower, there will be a recovery.
However, Dolphin remains cautious about the expectation of a recovery in Q4. Because it is not only the macro trend, but also in the medium and long term, Baidu still has an inescapable bug - traffic erosion.
On the one hand, short video platforms are still occupying user time, and on the other hand, whether it is competition from peers, such as Quark and Kimi, or other traffic platforms, they are also penetrating search, all pointing to the erosion of Baidu's search traffic. The net increase in MAU in Q2, Dolphin believes, is more likely due to AI trial users, but the DAU trend disclosed by third-party data is not good, indicating that the stickiness of existing users may still be declining, so the growth of MAU is recommended to be observed for sustainability.
Therefore, Dolphin still believes that before AI brings a more significant "net increase" contribution to advertising (not just the internal balance of different advertising forms), after enjoying the benefits of the dismantling of internet giants, Baidu's traditional advertising business, in addition to relying on the macro, is still difficult to achieve an independent advantage.
3. Cloud business slightly accelerated: The intelligent cloud business continues to accelerate along the trend of the previous quarter, with a year-on-year increase of 14%. Compared to the promotion of advertising, the demand for enterprises to use AI may contribute more significantly to the revenue growth of intelligent cloud (currently, the API daily average call in August has exceeded 600 million times, a rapid increase from the 200 million times disclosed in May).
4. Autonomous driving is booming: After excluding the intelligent cloud revenue, the remaining businesses such as Xiaodu, intelligent transportation, and autonomous driving no longer declined in Q2, with a year-on-year increase of 2.8%. Luobo Kuaibao is a highlight, with 400 vehicles currently deployed in Wuhan all being unmanned, and has provided services to 9 million users. As the proportion of unmanned vehicles increases, the operating cost per vehicle has decreased by 50%. After the subsequent low-cost RT6 vehicles (each vehicle 250,000, compared to RT5's 480,000, a decrease of nearly 50%) are put into the market, it is expected to further optimize UE.
5. Repurchase and cash: Q2 free cash flow was 5.9 billion, a year-on-year decline of 17%, mainly due to the decline in operating cash flow.
Although the current operating profit increased year-on-year, it was mainly due to the reduction of expenses that do not affect cash flow, such as equipment depreciation, content copyright amortization costs, and employee equity incentive expenses, and other operating expenses, so the operating cash flow still decreased by nearly 2 billion compared to last year. The investment in AI servers and chips led to a capital expenditure that decreased by 22% year-on-year.
The scale of Baidu's repurchase in Q2 increased slightly compared to the previous quarter, consuming 300 million US dollars, corresponding to an annualized dividend yield of about 4%. Including iQIYI (a net debt of 150 million in 2Q24), the company still has a total of 162 billion RMB in investments + cash. If short-term interest-bearing debt (including loans, bills, and convertible bonds) is deducted, the corresponding net cash is 149.5 billion RMB, or 20.7 billion US dollars, which is still relatively abundant. Looking at the proportion of repurchase expenditure, the company is more inclined to retain cash for subsequent business investment and short-term and long-term deposits/financial products (in Q2, more than 20 billion short-term funds were shifted to long-term fixed deposits).
6. A detailed look at the financial report data
Dolphin's view
Baidu's Q2 performance was mainly due to the market's low expectations and the strong optimization of expenses, which ultimately resulted in a significant profit beat.
However, due to the macro environment and the penetration of non-commercialized AI search, the pressure in the second half of the year is also visible. In the medium and long term, Dolphin has always been worried about the traffic erosion issue. Although the short-term monthly active users have returned, it has not been fundamentally relieved. In addition, the user penetration of Wenxin Yiyan in the C-end has also been surpassed by Doubao, and the growth momentum has also slowed down. In this case, it is difficult to reduce doubts about whether AI can bring a net increase to search advertising in the future.
As for the choice of continuing to promote AI search at the expense of short-term profits, Dolphin believes that at least from the perspective of traffic defense, it is something Baidu has to do. Some funds that care about EPS will inevitably be uncomfortable.
After the performance was released, Baidu's market value further shrank to 30 billion US dollars. At first glance, the net cash on hand is 20 billion US dollars, which seems to be overly underestimated. However, considering that Baidu's repurchase scale is too low, and in Q2, some short-term funds were transferred to long-term deposits, it means that the management may not plan to expand the repurchase efforts in the short term. Therefore, for some relatively cautious investors, the net cash here may not want to be included in the valuation, after all, there are many undervalued but high-repurchase companies in the current Chinese concept assets.
If being harsh, not considering net cash, but given the growth pressure of the Topline, Dolphin slightly reduces the market's performance expectations for next year. In this way, the current market value of 30 billion US dollars corresponds to the after-tax Non-GAAP operating profit of 2025 (15% effective tax rate), and the overall valuation is 9x. This means that if valued by parts, the current market value may imply that the advertising business only has a 7x valuation.
Therefore, if the interest rates are reduced and liquidity improves in the future, Baidu is expected to repair the valuation along with Chinese concept assets in the short term. However, whether the valuation can be maintained after the repair still depends on the changes in the macro environment.
The following is a detailed interpretation of the financial report
Baidu is a rare internet company that breaks down its performance in detail as:
1. Baidu Core: Covers traditional advertising business (search/information stream advertising) and innovative business (intelligent cloud/DuerOS Xiaodu speakers/Apollo, etc.);
2. iQIYI business: Membership, advertising, and copyright re-authorization, etc.
The divestiture of the two business segments is delineated, and with iQIYI being a separately listed company with detailed financial data available, Dolphin Investment Research has conducted an in-depth analysis of both operations. Given that there are approximately 1% (ranging from 200 to 400 million) of offsetting items between the two major businesses, the refined data for Baidu's core segments, as dissected by Dolphin Investment Research, may deviate slightly from the actual reported figures. However, this discrepancy does not impede the overall trend analysis.
I. The "double" pressure on advertising in the short term
Baidu Core advertising decreased by 2% year-on-year in Q2, slightly higher than the relatively conservative market expectations. Among them, the high gross margin managed page advertising accounted for a small rebound to 51%, an increase of 1 percentage point quarter-on-quarter.
Although there was the 618 e-commerce festival in Q2, consumption was relatively weak, especially for offline small and medium-sized businesses, and the willingness to invest decreased significantly. This is not a good thing for Baidu, which has a high proportion of offline small and medium-sized businesses.
The overall industry growth rebounded, mainly due to the accelerated investment under the competition of gaming and e-commerce platforms, and Baidu did not gain much from this due to traffic erosion.
The core reason is that Baidu's search ecosystem itself does not have an advantage, with only a high scale, but user stickiness and duration are relatively weak. However, the number of monthly users of the Baidu mobile app rebounded in Q2, with a net increase of 27 million. Dolphin guesses that this may be due to the penetration of AI search experience, attracting some user backflow.
But through the comparison of third-party data, the actual DAU of Shoubai actually declined in Q2, indicating that the increase in monthly active users may be mainly due to AI trial users, but the stickiness of existing users is still declining. In addition, although the activity of Wenxin Yiyan is still good, it has also been overtaken by Byte's Doubao.
In general, when AI is still a chicken rib function for most ordinary users (user education period), it is necessary to look at the hard strength of the traffic base camp. Byte's flood irrigation-type education penetration method is obviously due to the original traffic advantage. But on the other hand, does Baidu's weak traffic base camp mean that subsequent support for Wenxin Yiyan will gradually weaken?
Looking forward to Q3, the management has already given a growth pressure prevention injection, and it is expected that the decline will be greater than in Q2. But it is worth mentioning that there are indeed multiple factors acting at the same time in the short term.
1) The macro environment is the first to be affected. Dolphin does not make predictions about the subsequent trend and remains relatively cautious.
2) Proactively promote AI search. The proportion of AI search results in the user experience has reached 18% of the total search in Q2, an increase of 7 percentage points quarter-on-quarter. But so far, Baidu has not commercialized the content of AI search results, so actively promoting AI means that short-term monetization capabilities will definitely be affected.
But this is something Baidu has to do. In the irreversible trend of eroding traffic, promoting AI is the only way to regain user time. In addition, this round of AI changes also has a fatal disruptive logic for the proactive search entrance, so Baidu needs to actively change and sacrifice short-term profits for defensive purposes.
II. Intelligent cloud demand is stable, and there are many bright spots in autonomous driving
In Baidu Core's other businesses (non-advertising businesses), nearly 80% of the revenue comes from intelligent cloud, and the remaining 20% is mainly income from autonomous driving technology solutions, intelligent speakers, etc.
Other business revenue in Q2 was 7.5 billion, a year-on-year increase of 10%, mainly due to the low base + AI driving intelligent cloud, and the growth rate further increased to 14%. Other businesses outside of the intelligent cloud also returned to positive growth, among which Luobo Kuaibao is a highlight.
Intelligent cloud revenue grew by 14% in Q2, with the increase in demand for large models and the role of large model demand driving other cloud services, jointly driving growth.
Looking at the contribution of AI cloud to intelligent cloud revenue alone, it increased from 5% in the previous quarter to 9%. At the same time, the demand for public cloud from GPU customers has significantly increased. Excluding AI-related large model revenue, the growth rate of other cloud services also increased from 11.8% in the first quarter to 13.9% in this quarter.
In other businesses, autonomous driving is progressing rapidly. In Q2, Luobo Kuaibao provided a total of 899,000 rides, a year-on-year increase of 26% (the growth rate is the same quarter-on-quarter). As of July 28, Luobo Kuaibao's cumulative orders exceeded 7 million.
Currently, the 400 vehicles deployed in Wuhan are all unmanned and have provided services to 9 million users. As the proportion of unmanned vehicles increases, the operating cost per vehicle has decreased by 50%. After the subsequent lower-cost RT6 vehicles (each vehicle 250,000, compared to RT5's 480,000, a decrease of nearly 50%) are put into the market, it is expected to further optimize UE.
III. Profits exceeded expectations, and layoffs continued
For the market's concern about the weakening impact of AI investment on the profit side, there was some confirmation in Q2, but the impact on the overall gross margin is still controllable. However, as Gen-AI search gradually becomes commercialized in the second half of the year, the corresponding incremental costs should be seen.
Looking at Baidu's investment in AI servers and chips from capital expenditure, the capital expenditure in Q2 has fallen quarter-on-quarter and has even decreased by 22.4% year-on-year, which seems to mean that the high input in the past year has been temporarily halted. Of course, the specific changes may still depend on industry development changes, but for now, if there are no more blockbuster products on the downstream application side, Baidu's motivation to continue increasing capital expenditure should not be too high under short-term revenue pressure.
However, compared with the inevitable increase in server depreciation and other expenses in operating costs as AI business develops, the company's initiative is to adjust personnel salary expenses, which was also mentioned in our earnings review last quarter.
Like the first quarter, SBC expenses in the second quarter continued to decline by 28% year-on-year, indicating that the optimization mainly comes from layoffs/salary cuts, and the promotion expenses are estimated to have been reduced. In the end, Baidu Core's operating profit in the second quarter was 5.6 billion, with a profit margin of 21%, an improvement of 4 percentage points year-on-year, and also increased by 2 percentage points quarter-on-quarter, exceeding market expectations.