Baidu Preview: Cloud Revenue Likely Slow to Recover; Margin Expansion From Ad Recovery Intact

We are lowering our first-quarter 2023 revenue growth estimate for Baidu BIDU to 4% year on year from our previous estimate of 6%, and lowering our second-quarter growth estimate to 10% from 11%, due to the slow recovery of the cloud business. First-quarter results are expected in mid-May. However, our fair value estimate is unchanged at USD 183 (HKD 180) as our long-term thesis remains intact—we expect ad revenue to recover and drive margin expansion in the second quarter to 21%. We anticipate ad revenue to outpace China’s GDP growth in 2023, and the top categories to remain healthcare, e-commerce, and travel. In addition, Baidu indicated that it is also starting to see strength from offline retailers this quarter, as it is growing faster than its e-commerce peers.

We still expect cloud revenue to recover, but the pace of recovery will be slower than expected—cloud revenue will likely slow to 6% and 10% year over year in the first quarter and second quarter of 2023, respectively. However, cloud revenue should reaccelerate in the back half of 2023 to 15%, as we expect the cloud business to be intact. The slow pace of recovery is due to the project-based nature of the cloud business, rather than being subscription-based. Despite the near-term lag in recovery, management still expects its business to outpace that of its major competitors.

As for operating expenses due to its Ernie bot, we expect general and administrative expenses to increase slightly due to additional headcount, but for research and development to remain relatively constant, as Baidu is shifting resources from other departments to its Ernie product. We believe that the increased operating expense could offset some margin expansion driven by ad recovery, and that operating margins will likely not reach prepandemic levels of 33% in the long term due to increasing spending on Ernie. However, our thesis that operating margins will still expand to the mid-20s in the next three to five years remains intact.