In Parts 1 and Part 2 of my February edition of my Investment Decisions, I share my decisions to add new stocks to my portfolio. In Part 3, I share with you the thought process that led me to buy shares in Baidu. As always for every investment I incorporate my 8 Questions framework that allows me to do a proper size up of the key elements of the business and their stock. You can also find my podcast on my analysis here (iTunes).
Opened position in Baidu (Ticker: BIDU)
Q1: What do they sell?
Baidu, Inc.is a Chinese language Internet search provider. The Company offers a Chinese language search platform on its Baidu.com Website that enables users to find information online, including Webpages, news, images, documents and multimedia files, through links provided on its Website. It’s essentially the Chinese version of Google. In addition to serving individual Internet search users, the Company provides a platform for businesses to reach customers. Its business consists of three segments: search services, transaction services and iQiyi. Search services are keyword-based marketing services targeted at and triggered by Internet users' search queries, which mainly include its pay-for-performance (P4P) services and other online marketing services. Its transaction services include Baidu Nuomi, Baidu Takeout Delivery, Baidu Maps, Baidu Connect, Baidu Wallet and others. iQiyi is an online video platform with a content library that includes licensed movies, television series, cartoons, variety shows and other programs. It’s the Chinese version of Netflix.
These segments are where the core of the company’s cash flow is generated, however the company is making a very strong and aggressive push into the Artificial Intelligence space. It has developed a suite of AI tools called Apollo with a focus on developing tools to enable self-driving cars. AI requires immense amounts of data and given Baidu’s search capabilities it can easily amass enough quality real-time data to complement AI development. It also has voice-recognition suite of tools called DuerOS, which is comparable to Amazon’s Alexa ecosystem. Baidu is pivoting the company to be a leader in AI technology not just in China but globally. AI has been highlighted by the Chinese government as an area they want the nation to be a global leader and are putting immense resources and setting a target of 2030 to get the country there. Baidu with government backing has the potential to position itself as a major player. The core search and streaming business is essentially bankrolling the AI effort.
Q2: Who do they compete with?
Baidu serves the China market only and it’s main competitors are TenCent, Alibaba. Because Google and Netflix don’t operate in China, it has a very dominant presence on the Chinese internet. As it branches out into AI, its competitors will also come from the traditional auto manufacturers like Tesla and Blackberry as well as Google and Waymo which are also developing their own self-driving car technology.
Q3: Who buys their products and services?
Their core customer base is domestic. China. Baidu was crafted as a desktop search platform, however with mobile device much more prominent and available in China, the company was surpassed by upstarts like TenCent and Alibaba. The company has had to play a bit of catchup to get their mobile search platform and as such the stock has languished a bit in recent years. With this pivot to AI, the company hopes to expand its customer reach beyond China and become a more global player.
Q4: Will they buy their product over and over again?
It adverstising models going more online and less on traditional outlets, combined with essentially a captive customer base thanks to China’s conscious effort to keep companies like Facebook and Google out of the country, Baidu has been able to achieve a very loyal and sticky customer base.
Q5: Do they make money?
The company has been able to generate decent returns on invested capital that are greater than their cost of capital. Return on invested capital have been in a range of between 16 to 20 percent over the past few years compared to their cost of capital which has been in the 10.5 percent level. At the end, the companies I want to invest in, have to be creating tangible wealth and it appears Baidu is doing so.
Q6: What do they own and who do they owe money to?
The company’s financial position is pretty strong. From a liquidity perspective, Baidu has 2.5 times more current assets than current liabilities. Its debt/equity level comes in around 0.33 which is decent. The company has about 25 percent of its assets in intangible assets, so the quality of the firms capital is strong.
Q6: What do they own and who do they owe money to?
The company's financial position is pretty strong. Their current ratio is 2.5 meaning they have 2.5 times more current assets then current liabilities. This means they have more than enough short term liquidity to cover any day-to-day operational liabilities. In total they have about $16 billion in cash and about $5 billion in long-term debt. They have a manageable debt level at 0.33 Debt/Equity and finally the quality of their assets is reasonably with about 25 percent of their total assets classified as intangible. It's a company that is not going out of business any time soon.
Q7: How risky is their business?
Even though Baidu has a firm grasp on the search market, its tenuous as it can maintain it as long as the Chinese government allows it. One move that crosses them and they can take company down in a snap. It is probably a factor in the company trying to pivot to AI, to show support for the government and to stay in their good books. Their ability to build out their AI platforms will be driven by finding enough talent (which is very hard right now) as well ensuring a meaningful inflow of relevant data being captured by their search platform. If that well runs dry, there is a risk that their AI efforts will not pan out. The fact that they were late to the game in the mobile search is a bit of a precedent that there is a risk they could miss out on the next big pivot.
Q8: Is the stock cheap?
On a discounted cash flow basis, Baidu’s stock is fairly priced with intrinsic values coming in between $200 and $245. When I started to look at the stock it was trading at $250, but when the markets tanked early in February the stock fell a low as $214, so at the time it was trading at a discount. On a relative basis the stock is much cheaper than a comparable business like Google.
Baidu could be viewed as the cousin (albeit rich cousin) of Google. Baidu offers similar services as Google and their iQiy streaming has gotten so lucrative they may IPO it in the near future which would raise even more cash. That being said, if you are going to invest in Baidu, you have to base the decision on the future and the potential of Baidu becoming a major player in AI technology. They have a few things going for them that give it a good shot. First is strong Government support and backing. Second is their search platform is still dominant and as long as the Government gives them that captive user audience it will continue to be the best of breed company as long as they don’t upset the Government. The company is generating meaningful cash flow and Economic Profit. Their financial position is strong. When the stock fell to the $210-220 level during early February I thought it was a good time to open a small position and I decided to do so. If the market continued to track down, I would add more shares.