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Coffina: Baidu Should Reject Insider Offer For Video Site

In open letter to the Baidu CEO and Board, shareholder and StockInvestor Editor Matt Coffina spells out his objections to a proposed sale of video platform iQiyi.

On Feb. 12, 2016, Chinese search engine

Morningstar StockInvestor

owns Baidu in its real-money Hare portfolio, and

StockInvestor

editor Matt Coffina weighed in with the following message to the CEO and the independent directors.

An open letter to the CEO and independent directors of Baidu Inc.

To: Messrs. Penner, Callinicos, and Ding, and CEO Robin Li,

I am a long-time Baidu shareholder, both personally and professionally. BIDU was the first stock I bought when I became editor of the Morningstar StockInvestor newsletter, and I have used the newsletter to express my steadfast support for your efforts since then, including through the heavy investment spending and margin contraction of the past several years. I remain a firm believer in the long-run potential of your business.

However, I was severely disappointed with the recent proposal by Messrs. Li and Gong to acquire Baidu’s leading online video asset, iQiyi. I urge Robin Li to withdraw his proposal, and the independent directors to reject the offer. I do not believe such a transaction would be in the long-run interests of Baidu shareholders for the following reasons:

  1. I expect that iQiyi's own prospects will also be hurt by this transaction, since the company will lose access to Baidu's enormous cash flow. IQiyi was a 5.4 percentage point drag on Baidu's non-GAAP operating margin in the third quarter, implying run-rate operating losses of more than $150 million per quarter. Without access to Baidu's cash, iQiyi would have to fund these losses externally, diluting shareholders and impairing its ability to compete for the highest-quality video content.
  2. Lastly, iQiyi's impact on Baidu's operating profit is dwarfed by that of the O2O investments, which were a 32 percentage point drag on Baidu's non-GAAP operating margin in the third quarter. If maximizing reported profitability is your goal, then Baidu should prioritize finding a new home for O2O—such as a combination with Meituan, similar to the recent deal with Ctrip—rather than divesting iQiyi.

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About the Author

Matthew Coffina

Strategist

Matt Coffina, CFA, is a portfolio manager for Morningstar’s Investment Management group and edits Morningstar® StockInvestorSM, Morningstar’s flagship stocks newsletter. As part of his role as editor, Coffina manages the publication’s two real-money, market-beating model portfolios: the Tortoise and the Hare.

Previously, Coffina was a senior equity analyst, covering managed care and pharmaceutical services companies. In 2012, he ranked third in the Food and Drug Retailers category in The Wall Street Journal’s annual “Best on the Street” analysts survey. Coffina also developed the discounted cash flow model used by Morningstar analysts to assign fair value estimates to most of the companies in its global coverage universe. He joined Morningstar in 2007.

Coffina holds a bachelor’s degree in economics from Oberlin College. He also holds the Chartered Financial Analyst® designation.

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