Baidu’s stock price to drop nearly 30% by 2024. Is it a worthwhile move?

Baidu (BIDU) 0.61%) released its second-quarter earnings report on August 22. The Chinese tech giant’s revenue was virtually flat at 33.93 billion yuan ($4.67 billion), missing analysts’ expectations by $70 million. Adjusted earnings per American Depositary Share (ADS) fell 7% to $2.89, but still beat consensus forecasts by $0.29.

Baidu’s stock price fell after that mixed report, and is down nearly 30% this year. Some investors might view it as a deep value play at just 9 times forward earnings, but I wouldn’t buy it for four simple reasons.

Image source: Getty Images.

1. Baidu’s core business is withering

Baidu owns China’s largest online search engine, other portal websites and a majority stake in the streaming video platform iQiyi (I.Q -1.07%). In the first half of 2024, it generated 60% of its revenue from its online marketing services. That core business has faced tough macro, competitive and regulatory challenges in recent years.

Data source: Baidu. In RMB terms. YOY = Year-on-year.

On the macro front, China’s weak economy has curbed the market’s appetite for new ads. On the competitive front, many advertisers have shunned Baidu and bought more ads on higher-growth platforms such as ByteDance’s Douyin (known abroad as TikTok) and Tencent‘S (TCEHY 0.33%) Weixin (also known as WeChat). New generative AI tools are gradually eroding Baidu’s core search engine, and more and more companies are also buying directly sponsored listings and ads on Alibaba‘S (BABA -4.27%) e-commerce platforms and other marketplaces instead of Baidu’s search and display ads.

As Baidu juggled these challenges, Chinese regulators cracked down on several of the fastest-growing industries, including video games, streaming video, e-commerce and online education. The crackdown has slowed ad buys in those sectors.

Baidu tried to counter those headwinds by expanding its “managed business pages,” which allow the company to manage a brand’s entire presence across its ecosystem. That shift stabilized its online marketing efforts in 2023. Unfortunately, that momentum faded in the first half of 2024. It’s now trying to revitalize the business with new generative search tools powered by artificial intelligence (AI), but it admits those features could cannibalize its traditional search and display advertising.

2. Baidu’s cloud and AI growth slows down

As Baidu’s online marketing sales growth slowed, it expanded its cloud and AI division to offset the slowdown. That expansion turned its non-online marketing services unit into its new growth engine, but it also cooled in 2023 and 2024.

Data source: Baidu. Terms in RMB.

That segment, which accounted for 22% of revenue in the first half of 2024, is also facing intense macro and competitive challenges. The macro headwinds have forced many companies to rein in their cloud spending over the past two years, with Baidu’s underdog AI cloud platform struggling to keep pace with larger cloud rivals such as Alibaba, Huawei and Tencent. Those three market leaders controlled 74% of China’s cloud infrastructure market at the end of 2023, according to Canalys.

Baidu expects the AI ​​market’s growth to provide long-term tailwinds for its cloud business, but that acceleration is unlikely to offset the sluggishness of its marketing business. It also may struggle to expand its cloud and AI businesses as the U.S. tightens export restrictions on advanced AI chips to Chinese companies.

3. Baidu focuses too much on its margins and share buybacks

As Baidu’s revenue growth slowed, it aggressively cut costs to stabilize its margins. From 2021 to 2023, its adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) margin rose from 20% to 26%. That figure held steady at 26% in the first quarter of 2024 and rose to 27% in the second quarter.

Baidu has also been pouring a lot of its money into buybacks. It has already bought back $1.2 billion worth of shares from its $5 billion buyback plan, which it launched in February of last year.

Bulls may see those strategies as disciplined moves aimed at stabilizing earnings growth, but they also signal a maturing business. Those conservative strategies could also hamper Baidu’s ability to keep pace with more nimble rivals in the advertising, cloud and AI markets.

4. It deserves its discount rating

Analysts expect Baidu’s revenue to rise just 1% this year, while adjusted earnings are expected to fall 3%. It’s also likely to remain out of favor for a long time, as the U.S.-China tech war rages on, driving many investors away from Chinese stocks. Even if you’re willing to take a chance on Chinese stocks, there are better long-term plays than Baidu. Alibaba and Tencent are better diversified and generate steadier growth, but they trade at just 10x and 15x forward earnings, respectively. Baidu’s stock seems cheap, but it deserves its discount valuation, and I wouldn’t touch it until it sees a few more green shoots.