INTERNET: Baidu Surges on Investor Hopes for Cost Cuts

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Bottom line: An aggressive new share buy-back and tie-up between its Qunar unit and former rival Ctrip could indicate a new pragmatism from Baidu chief Robin Li, signaling a potential new era of more realistic spending on its emerging businesses.

Baidu jumps on mixed report
Baidu jumps on mixed report

Investors hoping for new signs of restrained spending in the latest results from Baidu (Nasdaq: BIDU) were disappointed, as China’s leading search engine continued a recent spending frenzy that has sharply eroded profits. But that didn’t stop those same investors from bidding up Baidu’s shares after release of its third-quarter results, leading me to believe they’re hoping the spending frenzy may soon start to subside. We saw some signs that may be happening earlier this week, following a landmark tie-up between Baidu’s Qunar (Nasdaq: QUNR) online travel site and former archrival Ctrip (Nasdaq: CTRP).

Despite its frenetic expansion outside its core search business over the last year, Baidu remains largely a one-trick pony, deriving most of its revenue from its core online search business. It has found some success in some newer areas, such as online video, travel services and group buying. But the reality is that those businesses are still quite small in terms of revenue contribution, and all are losing big money as Baidu allows them to spend heavily in pursuit of market share.

The heavy spending saw Baidu’s costs swell by 66 percent in the third quarter to a whopping 15.9 billion yuan ($2.5 billion), equal to 90 percent of its total revenue that grew by a slower 36 percent to 18.4 billion yuan. (company announcement; Chinese article) Online marketing services associated with its search business accounted for the vast majority of Baidu’s revenue, or around 96 percent. The aggressive spending eroded Baidu’s profits, which tumbled 31 percent to 2.5 billion yuan.

Baidu also said that it purchased $1 billion worth of its shares under an aggressive buyback program that it announced in July. It added that its board has just authorized a new program that will let it purchase $2 billion worth of shares over the next 24 months. Last but not least, the company said it expects fourth-quarter revenue growth to slow a bit to about 31 percent, with a forecast of 18.2 billion yuan to 18.8 billion yuan for the quarter.

Shares Jump

The numbers looked decidedly mixed, especially the big profit drop, continued ballooning expenses and slowing revenue growth. But that didn’t stop investors from bidding up Baidu shares by 6.8 percent in after-hours trade after it announced the results. Some reports pointed out the profit topped analyst forecasts, indicating investors had feared the company’s aggressive spending might be even higher than the actual amount. Investors also probably liked the new buy-back, which would amount to about 5 percent of all Baidu’s shares if it spends the entire $3 billion.

But perhaps investors are most hopeful that Baidu is preparing to pare back its broader aggressive spending, following its announcement this week of a major equity tie-up that will see Ctrip and Qunar transform from bitter rivals to new bedfellows. (previous post) That move alone could save Baidu big money, since Qunar had been seeing its spending and losses balloon as it battled Ctrip for market share.

Baidu founder Robin Li has said on numerous occasions that he sees a bright future in online to offline (O2O) services like travel, group buying and take-out dining services. His liberal spending in those areas became clear when the company released its last quarterly report, sparking a sell-off that saw its stock lose more than a third of its value and prompted it to launch the first $1 billion share buy-back.

The Qunar-Ctrip tie-up certainly looks like a positive sign, and perhaps investors are hoping that Baidu will find similar partners for its iQiyi online video service, its Nuomi group buying site or its take-out dining delivery service, all of which have become big money burners. Those hopes could be well-founded, since the Ctrip-Qunar tie-up seems to indicate a newer pragmatism by Robin Li, who previously seemed averse to M&A that forced him to relinquish some control of his assets.

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