Baidu, Inc. NASDAQ: BIDU Recommendation: BUY · 2019-09-12 · Investment Thesis 2 Recommendation:...

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Baidu, Inc.NASDAQ: BIDU

Recommendation: BUY

Rafa Campos and Ryan Ciemny

Investment Thesis

2

Recommendation: Baidu, Inc. (NASDAQ: BIDU) is undervalued in the market with substantial long-term upside, therefore we recommend a buy – recent pullback due to trade concerns and potential Google re-entry provides great entry opportunity

Rationale: Baidu’s strong fundamental business model and dominant market share put the Company in a good position to capitalize on growing access to internet in China

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Strong growth in video streaming platform iQiyi

Solid core business to be enhanced by investment in AI

Dominant search engine in a market with strong regulatory barriers to entry

Cheap opportunity to initiate portfolio exposure to Chinese economy

Price Target: $295.37

36.6% upside to current price of $216.24

Company Overview

3

Company Profile Historical Stock Chart

2017 Revenue by Segment Revenue Breakdown ($ in millions)

Volume (000’s) Baidu is the leading Chinese internet search provider with 80%

of the Chinese search engine market share

Baidu operates a business model similar to that of Google deriving the majority of its revenue from online marketing and advertising services

Baidu competes with Tencent and Alibaba as the top 3 leaders in the Chinese tech market

Baidu.com is the fourth largest website globally based on average daily visitors and page views

The Company also invests in technology including artificial intelligence and autonomous driving

On March 30, 2018 Baidu’s video-streaming subsidiary iQiyihad its IPO but Baidu maintains 58% ownership

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20000

40000

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80000

100000

$100.00

$120.00

$140.00

$160.00

$180.00

$200.00

$220.00

$240.00

$260.00

$280.00

$300.00

$222.18

Online Marketing Services

86%

Other 14%

$4,647

$7,086

$9,357 $9,428 $10,688

$21

$81

$343 $880

$1,704

$4,668

$7,167

$9,699 $10,308

$12,392

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$0

$2,000

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$12,000

$14,000

2013 2014 2015 2016 2017

Online Marketing Services Other EBITDA Margin

Industry Overview

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Overview Market Share

137

210

298

384

457513

564618

649688

731772

0

100

200

300

400

500

600

700

800

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Baidu80%

Sogou7%

Qihoo 3603% Other

10%

Revenue Growth of Search Engines in China Internet Users in China (in millions)

$1,613

$2,760

$4,101

$6,122

$8,016

$10,009

$11,854

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

2010 2011 2012 2013 2014 2015 2016

Almost 50% of the Chinese population still does not have access to the Internet

Total advertising expenditure expected to increase in China as a result of increasing access

Mobile searches now comprise over 50% of all search queries globally

Mobile will continue to drive global ad spend for the foreseeable future

Baidu remains the leader in China, while Google is undisputed leader globally

Chinese economy still posting strong GDP growth, but investors fear slowing growth rates

Dominant search engine in China with strong barriers to entry

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Overview

Search Engine Optimization R&D Spend ($ in millions)

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Strong core business to be enhanced by investment in AI2

Baidu’s dominant 80% market share is protected by strong regulations against foreign competitors (i.e. Google)

Government censorship

Restriction of data transfer out of China

Cloud services must be operated by Chinese companies

Google employees and US politicians opposed to re-entry into China

Google pulled out of China in 2010 due to censorship concerns

When Google entered Chinese market from 2006-2010, Baidu still gained 17% market share

Google’s algorithms have historically struggled to deal with complexities in Chinese language

Baidu has significantly increased its investments into Research and Development related to Artificial Intelligence

Integration of AI into search engine leads to better user experience

Higher customer ROI from improvements related to AI investments driving top line growth

Current investment in autonomous vehicles could lead to long-term leadership in China

$1,020

$1,487 $1,483

$1,889

2014 2015 2016 2017

Recent Developments

Growth in video streaming platform iQiyi

61Difference in revenue is due to rounding.

Company Overview Market Share of Online Video Streaming in China

Projected User Growth and Market Penetration Revenue Growth by Segment ($ in millions)1

$4,516

$6,948 $8,947 $8,689

$9,889 $197

$420

$777 $1,642

$2,539

$4,713

$7,368

$9,724 $10,331

$12,428

$0

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

$14,000

2013 2014 2015 2016 2017Baidu Core iQIYI

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iQiyi is China’s largest internet video streaming service in terms of user time spent and total MAUs

Q2 2018 Subscriber growth of 75% from a year ago totaling 67.1 million subscribers

Emphasis on investment in content development

In December 2017 users spent an average of 1.7 hours per day watching video content on iQiyi mobile apps

iQiyi Paopao is the company’s entertainment based social media platform for fans to interact with celebrities

Baidu - iQiyi31%

Tencent Video24%

Alibaba - Youku16%

Other29%

82.994.4

106.5118.1

128.6 137.5 144.96.0%

6.8%7.7%

8.5%9.2%

9.9%10.4%

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2016 2017 2018 2019 2020 2021 2022

Number of internet users (in millions) Penetration Rate

Opportunity for portfolio exposure to Chinese economy

71Difference in revenue is due to rounding.

Chinese Internet Users and Penetration Rate (in millions)

Growth of Chinese Middle Class Portfolio Overview – International Exposure

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137

210

298

384

457513

564618

649688

731772

11%

16%

23%

29%

34%38%

42%46%

48%50%

53%56%

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2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

92%

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United States

Other

Key Risks

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Dominant market share and regulatory constraints prevent foreign companies and smaller players from significantly threatening Baidu’s leadership

Google’s algorithms have historically struggled to deal with complexities in Chinese language

Google re-entry still unofficial and not supported by US Senate and Google employees

Baidu has lost and regained market share before, and search engine optimization through AI should maintain company’s edge in the long run

iQiyi well positioned to capitalize on market growth due to significant recent spend on original content

China is still expected to post strong economic growth and trade war is not expected to affect ad spend significantly

Revenue concentration – 99% of revenue comes from China

Shift to mobile – since Baidu doesn’t control an operating system, this could favor Google’s re-entry

Potential Google re-entry into Chinese market

Increased competition from Tencent and Alibaba in search engine space, especially in mobile

Increased competition in video streaming space

Marcoeconomic risk – trade war and overall slowing Chinese economy

Key Risks Mitigants

Final Recommendation

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Recommendation: Baidu, Inc. (NASDAQ: BIDU) is undervalued in the market with substantial long-term upside, therefore we recommend a buy

Base Case

Price Target: $295.37Upside: 36.6%

Upside Case


Downside Case


Appendix

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Products and ServicesBaidu Product / Service U.S. Equivalent

Search

Web Search Google Search / Chrome

Image Search Google Images

Hao123.com Website Directory

DuerOS Alexa

Social

Post Bar Reddit

User-Generated Content

Baidu Knows Yahoo Answers

Baidu Encyclopedia Wikipedia

Baidu Wenku Google Docs

Location-Based Products

Baidu Maps Google Maps

Baidu Travel TripAdvisor

Mobile

Web Search / Browser / Assistant Google App / Siri

Mobile Guardian Anti-Malware

Transaction Services

Baidu Nuomi Local Services – Dining, Movies, Hotels

Baidu Takeaway Delivery Grubhub / UberEats

Baidu Wallet Apple Pay/Wallet (Collaboration with PayPal)

Baidu Cloud iCloud

Baidu Apollo Waymo (Self-Driving Car)

iQiyi Netflix / YouTube

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Valuation – Comparable Companies Analysis

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Market Enterprise EV / Revenue EV / EBITDA Price / Earnings

Company Ticker Capitalization Value 2017A LTM 2017A LTM 2017A LTM

Alibaba Group Holding Limited BABA $422,388 $415,512 10.3x 10.1x 25.8x 33.7x 48.8x 49.1x

58.com Inc. WUBA 10,560 9,706 6.6x 5.8x 29.7x 25.6x 95.0x 43.4x

Weibo Corporation WB 16,102 15,414 16.0x 10.5x 43.5x 28.3x 88.5x 34.8x

Alphabet Inc. GOOG.L 829,772 731,499 5.9x 5.9x 18.2x 19.1x 35.2x 51.8x

Sogou Inc. SOGO 2,986 1,943 3.8x 1.8x 24.0x 13.2x 62.2x 35.0x

Momo Inc. MOMO 9,249 8,826 4.6x 5.3x 16.2x 17.5x 16.6x 22.2x

Tencent Holdings Limited 700 448,555 453,732 13.8x 11.1x 33.8x 28.8x 53.8x 32.8x

Baidu, Inc. BIDU $75,707 $64,998 5.8x 4.7x 18.1x 14.0x 30.8x 19.8x

Low $2,986 $1,943 3.8x 1.8x 16.2x 13.2x 16.6x 22.2x

Mean 248,516 233,804 8.7x 7.2x 27.3x 23.8x 57.2x 38.4x

Median 16,102 15,414 6.6x 5.9x 25.8x 25.6x 53.8x 35.0x

High 829,772 731,499 16.0x 11.1x 43.5x 33.7x 95.0x 51.8x

Operating StatisticsRevenue Revenue Growth EBITDA EBITDA Margin

Company Ticker 2017A LTM '16-'17A LTM 2017A LTM 2017A LTM

Alibaba Group Holding Limited BABA $23,126 $41,059 56.5% 59.4% $9,219 $12,328 39.9% 30.0%

58.com Inc. WUBA 1,471 1,664 32.6% 30.6% 326 379 22.2% 22.8%

Weibo Corporation WB 1,150 1,474 75.4% 75.0% 423 544 36.8% 36.9%

Alphabet Inc. GOOG.L 110,855 123,898 22.8% 24.8% 35,781 38,205 32.3% 30.8%

Sogou Inc. SOGO 908 1,085 37.5% 52.6% 143 147 15.8% 13.6%

Momo Inc. MOMO 1,318 1,670 138.3% 70.3% 373 505 28.3% 30.2%

Tencent Holdings Limited 700 34,740 40,738 56.5% 46.4% 14,122 15,753 40.6% 38.7%

Baidu, Inc. BIDU $12,392 $13,724 20.2% 26.5% $4,008 $4,637 32.3% 33.8%

Low $908 $1,085 22.8% 24.8% $143 $147 15.8% 13.6%

Mean 24,796 30,227 59.9% 51.3% 8,627 9,694 30.8% 29.0%

Median 1,471 1,670 56.5% 52.6% 423 544 32.3% 30.2%

High 110,855 123,898 138.3% 75.0% 35,781 38,205 40.6% 38.7%

Valuation – WACC

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WACC Calculation

Capital Structure

Debt-to-Total Capitalization 9.2%

Equity-to-Total Capitalization 90.8%

Cost of Debt

Cost of Debt 3.5%

Tax Rate 19.1%

After-tax Cost of Debt 2.82%

Cost of Equity

Risk-free Rate(1) 2.9%

Market Risk Premium(2) 7.0%

Levered Beta 1.5

Cost of Equity 13.36%

WACC 12.39%

Valuation – DCF (Base)

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FYE December 31, FYE December 31,

($ in millions) 2014A 2015A 2016A 2017A 2018E 2019E 2020E 2021E 2022E 2023E 2024E

Total Revenue $7,167.3 $9,699.4 $10,308.3 $12,391.9 $15,327.1 $18,306.2 $21,331.5 $24,237.0 $27,225.9 $29,784.3 $32,411.2

Revenue Growth 35.3% 6.3% 20.2% 23.7% 19.4% 16.5% 13.6% 12.3% 9.4% 8.8%

Expenses

COGS 2,759.4 4,012.0 5,154.7 6,292.0 7,935.6 9,661.2 11,471.1 13,275.9 14,913.1 16,314.5 17,753.3

Gross Profit $4,407.9 $5,687.4 $5,153.6 $6,099.9 $7,391.4 $8,645.1 $9,860.4 $10,961.1 $12,312.9 $13,469.9 $14,657.9

Gross Margin 61.5% 58.6% 50.0% 49.2% 48.2% 47.2% 46.2% 45.2% 45.2% 45.2% 45.2%

SG&A 1,517.0 2,495.1 2,202.1 1,918.2 3,208.4 3,832.0 4,465.3 5,073.5 5,699.1 6,234.7 6,784.6

R&D 1,020.0 1,486.9 1,483.2 1,889.0 2,336.4 2,882.1 3,465.0 4,058.2 4,694.8 5,284.8 5,913.0

Operating Expenses 2,537.0 3,981.9 3,685.3 3,807.2 5,544.8 6,714.1 7,930.3 9,131.6 10,393.9 11,519.5 12,697.6

Operating Income (EBIT) $1,870.9 $1,705.5 $1,468.3 $2,292.7 $1,846.7 $1,931.0 $1,930.1 $1,829.5 $1,919.0 $1,950.4 $1,960.3

EBIT Margin 26.1% 17.6% 14.2% 18.5% 12.0% 10.5% 9.0% 7.5% 7.0% 6.5% 6.0%

Income Tax Expense (19%) 326.0 800.0 425.6 437.6 352.5 368.6 368.4 349.2 366.3 372.3 374.2

EBIAT $1,544.9 $905.5 $1,042.7 $1,855.1 $1,494.2 $1,562.4 $1,561.7 $1,480.3 $1,552.7 $1,578.1 $1,586.2

Cash Flow

Plus: D&A 576.3 854.5 1,215.7 1,715.4 2,121.7 2,534.1 2,952.9 3,355.1 3,768.9 4,123.0 4,486.6

Plus: Stock Based Compensation 5.1 7.3 15.1 26.7 33.1 39.5 46.0 52.3 58.7 64.3 69.9

Discretionary Cash Flow $2,126.2 $1,767.2 $2,273.5 $3,597.2 $3,649.0 $4,136.0 $4,560.6 $4,887.7 $5,380.3 $5,765.4 $6,142.7

Less: Increase in NWC (687.6) (621.6) (823.8) (960.7) (1,315.9) (1,110.9) (1,243.4) (1,085.0) (896.7) (767.5) (788.1)

Less: CapEx (706.0) (767.3) (615.9) (705.6) (1,127.6) (1,346.8) (1,569.4) (1,783.2) (2,003.1) (2,191.3) (2,384.5)

Free Cash Flow $732.6 $378.4 $833.8 $1,930.9 $1,205.4 $1,678.3 $1,747.8 $2,019.5 $2,480.6 $2,806.6 $2,970.1

Free Cash Flow Growth -- (48.3%) 120.3% 131.6% (37.6%) 39.2% 4.1% 15.5% 22.8% 13.1% 5.8%

Unlevered Free Cash Flow

WACC 12.39%

Discount Period 0.5 1.5 2.5 3.5 4.5 5.5 6.5

Discount Factor 0.94 0.84 0.75 0.66 0.59 0.53 0.47

Present Value of Free Cash Flow $1,137.0 $1,408.5 $1,305.1 $1,341.8 $1,466.3 $1,476.1 $1,389.9

Valuation – DCF (Base)

15

DCF Sensitivity Analysis

WACC

263.26 10.4% 11.4% 12.4% 13.4% 14.4%

21.8x $271.07 $258.13 $246.03 $234.69 $224.06

22.8x $280.75 $267.27 $254.64 $242.82 $231.74

EV/EBITDA 23.8x $290.44 $276.40 $263.26 $250.96 $239.43

24.8x $300.12 $285.53 $271.88 $259.09 $247.11

25.8x $309.81 $294.66 $280.50 $267.23 $254.79

Enterprise Value DCF Sensitivity Analysis

Cumulative Present Value of FCF $9,524.8

Terminal Value

Terminal Year EBITDA $6,447.0

Exit Multiple 23.8x

Terminal Value $153,124.3

Discount Factor 46.80%

Present Value of Terminal Value $71,656.5

% of Enterprise Value 88.3%

Enterprise Value $81,181.3

DCF Implied Equity Value and Share Price


Less: Total Debt $7,655.8

Plus: Cash & Cash Equivalents $18,642.0

Implied Equity Value $92,167.5

Implied Share Price $263.26

Shares Outstanding 350

Comps Implied Equity Value and Share Price







Method Weight Price Upside

Comparable Companies 30% $370.30 71.2%

DCF 70% $263.26 21.7%

Fair Value Estimate $295.37 36.6%

Valuation – DCF (Upside)

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Total Revenue $7,167.3 $9,699.4 $10,308.3 $12,391.9 $15,486.6 $18,692.0 $21,922.8 $25,269.8 $29,003.1 $32,668.1 $36,334.9

Revenue Growth 35.3% 6.3% 20.2% 25.0% 20.7% 17.3% 15.3% 14.8% 12.6% 11.2%

Expenses

COGS 2,759.4 4,012.0 5,154.7 6,292.0 8,018.2 9,864.7 11,789.0 13,588.9 15,596.5 17,567.3 19,539.2

Gross Profit $4,407.9 $5,687.4 $5,153.6 $6,099.9 $7,468.4 $8,827.2 $10,133.7 $11,680.9 $13,406.6 $15,100.7 $16,795.7

Gross Margin 61.5% 58.6% 50.0% 49.2% 48.2% 47.2% 46.2% 46.2% 46.2% 46.2% 46.2%

SG&A 1,517.0 2,495.1 2,202.1 1,918.2 2,852.8 3,443.2 4,038.4 4,654.9 5,342.7 6,017.8 6,693.2

R&D 1,020.0 1,486.9 1,483.2 1,889.0 2,360.7 2,942.8 3,561.1 4,231.1 5,001.2 5,796.5 6,628.8


Operating Income (EBIT) $1,870.9 $1,705.5 $1,468.3 $2,292.7 $2,254.9 $2,441.2 $2,534.3 $2,794.9 $3,062.8 $3,286.4 $3,473.6

EBIT Margin 26.1% 17.6% 14.2% 18.5% 14.6% 13.1% 11.6% 11.1% 10.6% 10.1% 9.6%


EBIAT $1,544.9 $905.5 $1,042.7 $1,855.1 $1,824.5 $1,975.2 $2,050.6 $2,261.4 $2,478.2 $2,659.1 $2,810.6

Cash Flow

Plus: D&A 576.3 854.5 1,215.7 1,715.4 2,143.8 2,587.5 3,034.7 3,498.1 4,014.9 4,522.2 5,029.8



Less: Increase in NWC (687.6) (621.6) (823.8) (960.7) (1,355.8) (1,175.2) (1,310.8) (1,223.3) (1,120.0) (1,099.5) (1,100.0)

Less: CapEx (706.0) (767.3) (615.9) (705.6) (1,139.4) (1,375.2) (1,612.9) (1,859.1) (2,133.8) (2,403.4) (2,673.2)

Free Cash Flow $732.6 $378.4 $833.8 $1,930.9 $1,506.2 $2,051.9 $2,207.7 $2,729.3 $3,298.0 $3,742.7 $4,137.1

Free Cash Flow Growth -- (48.3%) 120.3% 131.6% (22.0%) 36.2% 7.6% 23.6% 20.8% 13.5% 10.5%


WACC 12.39%

Discount Period 0.5 1.5 2.5 3.5 4.5 5.5 6.5

Discount Factor 0.94 0.84 0.75 0.66 0.59 0.53 0.47

Present Value of Free Cash Flow $1,420.7 $1,722.0 $1,648.5 $1,813.3 $1,949.5 $1,968.5 $1,936.0

Valuation – DCF (Upside)

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Terminal Value


Exit Multiple 23.8x






Implied Equity Value and Share Price















WACC

336.93 10.4% 11.4% 12.4% 13.4% 14.4%

21.8x $347.26 $330.18 $314.20 $299.22 $285.19

22.8x $360.03 $342.23 $325.56 $309.95 $295.33

EV/EBITDA 23.8x $372.81 $354.27 $336.93 $320.68 $305.46

24.8x $385.58 $366.32 $348.29 $331.42 $315.60

25.8x $398.35 $378.37 $359.66 $342.15 $325.73



DCF 70% $336.93 55.8%


Valuation – DCF (Downside)

18



Total Revenue $7,167.3 $9,699.4 $10,308.3 $12,391.9 $14,792.7 $16,300.0 $17,156.7 $17,769.7 $18,300.1 $18,791.3 $19,268.6

Revenue Growth 35.3% 6.3% 20.2% 19.4% 10.2% 5.3% 3.6% 3.0% 2.7% 2.5%

Expenses

COGS 2,759.4 4,012.0 5,154.7 6,292.0 7,840.1 8,802.0 9,436.2 9,951.0 10,431.0 10,899.0 11,175.8

Gross Profit $4,407.9 $5,687.4 $5,153.6 $6,099.9 $6,952.6 $7,498.0 $7,720.5 $7,818.7 $7,869.0 $7,892.3 $8,092.8

Gross Margin 61.5% 58.6% 50.0% 49.2% 47.0% 46.0% 45.0% 44.0% 43.0% 42.0% 42.0%

SG&A 1,517.0 2,495.1 2,202.1 1,918.2 3,096.5 3,412.0 3,591.4 3,719.7 3,830.7 3,933.5 4,033.4

R&D 1,020.0 1,486.9 1,483.2 1,889.0 2,254.9 2,566.2 2,786.9 2,975.3 3,155.6 3,334.3 3,515.3


Operating Income (EBIT) $1,870.9 $1,705.5 $1,468.3 $2,292.7 $1,601.1 $1,519.7 $1,342.3 $1,123.7 $882.7 $624.5 $544.1

EBIT Margin 26.1% 17.6% 14.2% 18.5% 10.8% 9.3% 7.8% 6.3% 4.8% 3.3% 2.8%


EBIAT $1,544.9 $905.5 $1,042.7 $1,855.1 $1,295.5 $1,229.7 $1,086.1 $909.2 $714.2 $505.3 $440.2

Cash Flow

Plus: D&A 576.3 854.5 1,215.7 1,715.4 2,047.7 2,256.4 2,375.0 2,459.8 2,533.3 2,601.3 2,667.3



Less: Increase in NWC (687.6) (621.6) (823.8) (960.7) (1,182.3) (702.8) (574.4) (355.5) (159.1) (147.4) (143.2)

Less: CapEx (706.0) (767.3) (615.9) (705.6) (1,088.3) (1,199.2) (1,262.2) (1,307.3) (1,346.4) (1,382.5) (1,417.6)

Free Cash Flow $732.6 $378.4 $833.8 $1,930.9 $1,105.7 $1,623.5 $1,670.4 $1,758.5 $1,800.8 $1,641.0 $1,616.7

Free Cash Flow Growth -- (48.3%) 120.3% 131.6% (42.7%) 46.8% 2.9% 5.3% 2.4% (8.9%) (1.5%)


WACC 12.39%

Discount Period 0.5 1.5 2.5 3.5 4.5 5.5 6.5

Discount Factor 0.94 0.84 0.75 0.66 0.59 0.53 0.47

Present Value of Free Cash Flow $1,042.9 $1,362.5 $1,247.3 $1,168.3 $1,064.5 $863.1 $756.5

Valuation – DCF (Downside)

19



Terminal Value


Exit Multiple 23.8x






Implied Equity Value and Share Price















WACC

154.77 10.4% 11.4% 12.4% 13.4% 14.4%

21.8x $159.04 $152.40 $146.19 $140.36 $134.90

22.8x $163.86 $156.95 $150.48 $144.41 $138.72

EV/EBITDA 23.8x $168.68 $161.50 $154.77 $148.46 $142.55

24.8x $173.51 $166.05 $159.06 $152.52 $146.38

25.8x $178.33 $170.60 $163.36 $156.57 $150.21



DCF 70% $154.77 -28.4%


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