Baidu: Wide Moat Remains Intact but Macroeconomic Headwinds and Other Risks Are Starting to Mount

We keep our Baidu 09888 fair value estimate of USD 183 (HKD 180) despite lowering our near-term estimates for the second half of 2023. Our revised revenue growth is 4%-5% from 9% year on year for the second half of 2023, and our new revenue forecast for third-quarter 2023 is CNY 33.9 billion from CNY 35.1 billion. We lower our core advertising revenue growth forecasts to 4% and 5% year on year from 8% and 10% for the third and fourth quarters, respectively, over macroeconomic weakness in China. While we are still seeing ad demand from travel and healthcare industries, we believe demand for advertising in e-commerce has declined in the third quarter. This is consistent with government-released statistics showing only a 4% year-on-year increase in the retail sector for the third quarter versus a 10%-11% increase in the second quarter. We also expect flat revenue growth year on year for Baidu’s cloud business for the rest of 2023, revised from 9%, as one of its key industries, smart transportation, is slowing down, due to lower government spending. Smart transportation projects from the government are billed as one-time contracts that make revenue generation lumpy and their timing unpredictable. Baidu remains upbeat that these contracts will eventually restart next year and that ad demand recovers in 2024, but also has less visibility into growth forecasts next year. We believe Baidu remains currently undervalued relative to our fair value estimate, but also expect greater share performance volatility, given its current macroeconomic and geopolitical headline risks.

The planned export restriction of Nvidia A800 and H800 chips by the U.S. government also deals a serious blow to the long-term potential of Baidu’s artificial intelligence business, in our view. While it has likely stockpiled chips in preparation for the restrictions that have been long under discussion, we are unsure how this will curtail the growth trajectory of both its AI cloud and generative AI businesses.