Baidu's "downfall," even AI cannot save it

$Baidu(BIDU.US) The quarterly report will be released after the Hong Kong stock market closes on February 18, 2025. The Q4 performance slightly exceeded expectations, mainly due to the cloud business. However, Dolphin Research believes that the Q4 performance itself is not the key to the current valuation. Although the cloud business will benefit from this round of Deepseek accelerating AI penetration, the valuation also depends more on how the management interprets this year's advertising outlook and the impact of changes in the search landscape brought by Deepseek, in addition to the age-old issue of shareholder return plans.

(The following text focuses on Baidu's fundamentals, thus only discussing Baidu's core performance.)

Specifically:

1. Advertising expectations under pressure, focus on outlook: In Q4, advertising continued to deteriorate, aligning with guidance and market expectations, which fits the backdrop of macro pressure and the decline in MAU for mobile Baidu. The decline in advertising, besides being influenced by macro and competitive landscape factors, also involves Baidu's own control over monetization—expanding AI search penetration while still restraining the commercialization of AI search advertising.

Last quarter, management revealed that in November, the penetration rate of AI search in Q&A volume reached 20%, with a user penetration rate of 50%. However, since Q4, Doubao and Deepseek have brought significant changes to the AI market and the traditional search competitive landscape, so it is worth paying close attention to whether Baidu will make any changes in its subsequent development strategy for AI search in response.

2. AI drives accelerated cloud demand: In Q4, the growth rate of smart cloud in other businesses was 26%, which is impressive and reflects the surging downstream AI demand.

The company disclosed that in December 2024, the daily average API call volume processed by the Wenxin large model reached 1.65 billion (internal + external), with external API call volume increasing by 178% month-on-month, showing strong momentum. Under the transformation brought by Deepseek, downstream applications are expected to accelerate AI penetration this year, so Baidu's smart cloud revenue will naturally benefit, leading to continued growth.

3. Rapid progress of Luobo Kuaipao: Excluding smart cloud revenue, the remaining businesses such as Xiaodu, smart transportation, and autonomous driving saw flat year-on-year growth and a decline quarter-on-quarter. This includes the impact of the closure of Jiyue, which resulted in a loss of related ADAS revenue, and confirmed losses becoming bad debts.

In Q4, Luobo Kuaipao received 1.1 million orders, a year-on-year increase of 36%, showing significant acceleration compared to Q3, mainly due to the accelerated progress under the expectation of optimizing the UE economic model, including deploying more vehicles and exploring more new areas. In November, Luobo Kuaipao entered the Hong Kong region and obtained autonomous driving testing permits. As of February this year, Luobo Kuaipao has achieved fully unmanned autonomous driving capabilities in all regions where it has been permitted to operate domestically.

4. Profit under pressure, with impacts from Jiyue loss provisions: In Q4, besides the impact of advertising pressure, profits were also affected by the recognition of related costs from the closure of Jiyue (one-time provisions for severance compensation and related losses of about 1 billion), resulting in a 22% year-on-year decline in operating profit After excluding this part of the impact, profits remained flat year-on-year and are still under pressure. However, these impacts were basically within market expectations, and because revenue met expectations while R&D expenses were lower than expected, the overall operating profit slightly beat expectations.

5. The importance of shareholder returns has increased: In the fourth quarter, Baidu's core free cash flow was negative, mainly due to a one-time impact from JiYue. In addition, capital expenditures also saw a certain increase quarter-on-quarter. Dolphin Research speculates that due to the continuously increasing demand for AI cloud services, the company has made moderate increases in investments related to infrastructure.

In the fourth quarter, Baidu's share repurchases increased quarter-on-quarter, but due to the small total scale, the impact was limited. Thus, for the entire year of 2024, Baidu's repurchases exceeded $1 billion, with zero dividends. Based on a market capitalization of $41.8 billion at the end of the year, the overall shareholder return yield is 2.3%, which is relatively low among Chinese concept assets.

However, as of the end of Q4, Baidu's core cash and short-term investments on the books still amounted to RMB 134.7 billion, most of which are wealth management products. Even after deducting short-term and long-term loans, there is still RMB 128.4 billion, nearly $18 billion in net cash. This is equivalent to 53% of the current total market value of $34 billion. During the past two years when share repurchases and dividends were popular among Chinese concepts, the market has been concerned about whether Baidu's ample cash situation could increase shareholder returns. Especially during the current period of performance pressure and damage to search logic, whether the management has plans to increase repurchases or dividends, or if they will continue to be frugal.

However, Dolphin Research feels it leans more towards the latter, at least in the short term. They have talked about shareholder returns for several quarters, but the management seems to be indifferent to shareholder demands, making no commitments and only stating that the intensity of repurchases will fluctuate with market value. In cash planning, not only is the proportion of repurchase spending extremely low from current cash flow, but they are also continuously depositing the cash flow generated from the business into long-term deposits/wealth management (adding RMB 10 billion in long-term deposits in the fourth quarter).

6. Detailed financial report data overview

Dolphin Research's Viewpoint

Dolphin Research is getting tired of discussing Baidu's issues, and now, even the most numb person would notice something is wrong. While Deepseek has sparked a nationwide AI craze, Baidu, as one of the first AI pioneers, has not only been easily surpassed but has also potentially accelerated the collapse of its search kingdom. Still, the same saying applies: in the foreseeable future, Baidu has only Beta, not Alpha.

Although in the short to medium term, the cloud business will indeed benefit from accelerated downstream AI demand, the damage to the fundamental logic is even more alarming. Therefore, this round of "revaluation of Chinese concept stocks" means that even if the cloud business can be revalued, it must also digest the expectation that advertising will continue to be eroded. After offsetting these opposing impacts, there may not be much room left for value revaluation.

Dolphin Research may also be worried about deeper issues: over the past decade since the mobile internet boom, Baidu has made significant investments in businesses outside of search, but ultimately still relies on its old search business In addition to AI, there have been strategic misjudgments and missed opportunities in various businesses such as extreme sports, live streaming, group buying, and mobile ecosystems. Will such deeply rooted management issues cause Baidu Cloud, which has just tasted the sweetness of AI, to repeat its past mistakes?

Moreover, from the current perspective, the management's disregard for shareholder demands and their reluctance to share profits while being miserly also leaves us speechless. Perhaps one day, the management will suddenly awaken and make a decisive "Tencent-style self-rescue" — announcing a large-scale long-term repurchase plan. However, it is important to recognize that in terms of business, without breaking, there can be no establishment. Dolphin Research suggests that we should have fewer expectations, as management issues cannot be resolved overnight to bring about a rebirth.

The following is a detailed interpretation of the financial report

Baidu is relatively rare among internet companies in breaking down its performance as follows:

Baidu Core: Covers traditional advertising business (search/information flow advertising) and innovative businesses (intelligent cloud/DuerOS Xiaodu speaker/Apollo, etc.);

iQIYI Business: Membership, advertising, and copyright licensing, among others.

The separation of these two businesses is clear-cut, and with iQIYI being an independently listed company with detailed data, Dolphin Research will also break down these two businesses in detail. Due to approximately 1% (between 200-400 million) of offsetting items between the two major businesses, the segmented data of Baidu Core that Dolphin Research breaks down may slightly differ from the actual reported figures, but it does not hinder trend judgment.

1. Advertising under pressure, how to view the pattern change?

In the fourth quarter, Baidu's core advertising declined by 6.6% year-on-year, slightly better than institutional expectations (which anticipated an 8% decline). The detailed performance of managed page advertising has not been mentioned by the company this quarter. Although there is macro pressure in the fourth quarter (internet giants have all lowered their advertising expectations in previews), the decline in monthly active users on Baidu undoubtedly indicates the competitive issues faced by Baidu Search.

Dolphin Research believes that the core reason is that Baidu's search ecosystem has further lost its situational advantage, leading to a poor search experience that allows traffic to be divided among competitors like Quark, Douyin, WeChat, and Xiaohongshu. This is also what Dolphin Research has consistently mentioned: although MAU occasionally grows, user duration and DAU are the core indicators that reflect whether situational demand has weakened.

However, this data is not disclosed by the company, so we can only look at third-party QM data, which shows that user stickiness and duration on Baidu in the fourth quarter remain weak.

In the segmented verticals of search engines, Baidu's market share continues to decline in the fourth quarter. However, it is well known that in user search scenarios, the in-app searches of Douyin, WeChat, and Xiaohongshu pose a greater threat to Baidu

Compared to social platforms like Douyin, Baidu's remaining search scenario is based on information from news/official web homepages (lifestyle, entertainment, and professional niche information have all been taken over by other platforms). However, the search scenario for basic text information actually has no barriers, and under Baidu's continuous neglect of user experience improvement, the last bastion is also being slowly eroded by similar platforms like Quark and cross-category platforms like Douyin and Xiaohongshu.

Another nuclear impact on Baidu's search fundamentals comes from WeChat, which recently announced its integration with Deepseek. The first application scenario after the integration is AI search, and as it also focuses on broad information text search scenarios, its invasion of Baidu is undoubtedly a heavy blow. Scenarios determine traffic, and traffic determines the quality data differences needed for the continuous optimization of subsequent models.

Looking solely at the terminal traffic of AI chatbots, Wenxin Yiyan no longer has an absolute advantage, and Kimi has also completed a leap in the fourth quarter. Therefore, if the demand for the search fundamentals represented by the mobile search scenario is also weakened, it will undoubtedly be fatal for Baidu.

Therefore, at this significant crossroads of change, the management's outlook for the future becomes particularly critical. This can be monitored during the conference call, and Dolphin Research will update the outlook in the comments section later. However, Dolphin Research believes that at least for Q1, there is still macro pressure, and if there is no further penetration of commercialized AI search for the time being, the drag on Baidu's advertising revenue growth will still be quite heavy.

II. AI demand is booming, and cloud business has a sustained reason for improvement

Among Baidu's core other businesses (non-advertising), nearly 80% of the revenue comes from smart cloud, while the remaining 20% mainly comes from autonomous driving technology solutions, smart speakers, and other revenues. In the fourth quarter, other business revenue reached 9.7 billion, a year-on-year increase of 18%, significantly accelerating compared to the previous quarter. Among them, smart cloud rebounded from the gloom of the third quarter, with a growth rate returning to 26%, which is very impressive.

The company disclosed that in December 2024, the average daily API call volume processed by the Wenxin large model reached 1.65 billion times (internal + external), with external API call volume increasing by 178% month-on-month, showing strong momentum. With the transformation brought by Deepseek, downstream applications are expected to accelerate AI penetration this year, thus benefiting Baidu Smart Cloud's revenue and continuing to enhance growth.

In addition to Smart Cloud, other businesses, such as Xiaodu, Smart Transportation, and Autonomous Driving, remained flat year-on-year in the fourth quarter and declined month-on-month. This is partly due to the closure of Jiyue, which resulted in a decrease in related ADAS revenue, and confirmed losses have also become bad debts.

In the fourth quarter, Luobo Kuai Pao received 1.1 million orders, a year-on-year increase of 36%, showing a significant acceleration compared to the 20% in the third quarter, mainly benefiting from the accelerated promotion under the expectation of optimizing the UE economic model, including deploying more vehicles and exploring more new areas. In November, Luobo Kuai Pao entered the Hong Kong region and obtained autonomous driving testing permits. As of February this year, Luobo Kuai Pao has achieved fully unmanned autonomous driving capabilities in all regions where it has been permitted to operate domestically.

3. Profit continues to decline beyond the provision for Jiyue losses

Due to the pressure on high-margin advertising, the accelerated growth of low-margin cloud business has caused the group's gross margin to continue to decline to 52%. In terms of capital expenditure, Baidu's investment in AI servers and chips saw a significant year-on-year contraction in the fourth quarter, but there are signs of a turning point month-on-month. Possibly due to the increased demand for enterprise AI in the fourth quarter, the company's investment in infrastructure has also moderately increased.

Since the beginning of this year, the low computing cost transformation brought by Deepseek has helped improve efficiency across the industry. However, for Baidu's AI cloud, it may not be a complete benefit. The savings in computing costs from Deepseek can be directly attributed to downstream applications, while for cloud service platforms, the competitive advantage of bundled services under non-closed self-research of large models declines, making it difficult to sell at a higher premium.

Baidu Cloud announced in early February the launch of Deepseek R1 and V3, which were free until February 19, and the pricing after the free period is lower than that of other platforms. Therefore, while this is beneficial for expanding Baidu Cloud's revenue, it also potentially compresses the profit margin originally brought (whether from the bundled premium of the Wenxin large model or the undiscounted Deepseek price).

Like the previous quarter, SBC expenses in the fourth quarter continued to decline significantly by 35% year-on-year. In addition to the impact of market value shrinkage, the company is also in a period of employee cost optimization, benefiting from both business adjustments and internal efficiency improvements brought about by AI.

Ultimately, Baidu's core operating profit in the fourth quarter was 3.6 billion, with a profit margin of 13%. The provision for losses from Jiyue approximately affected the profit margin by 3 percentage points. However, even excluding the 1 billion impact from Jiyue in management expenses, the operating profit remained flat year-on-year under revenue pressure, still showing a weakening trend.