2024-01-01 21:28:26 ET
Summary
- Baidu's Ernie Bot has attracted over 100 million users, indicating strong growth potential for Baidu's GenAI tool in China.
- The Ernie Bot still has room for growth, with only about 7% of the Chinese population registered.
- Baidu's integration of GenAI capabilities into its Cloud business could generate a positive feedback loop for growth.
- Meanwhile, market participants price Baidu like a simple advertising business, with shares trading at an EV/EBIT of about 9x.
- As a function of both business momentum and valuation, I upgrade Baidu stock to a "Strong Buy".
Baidu ( BIDU ) continues to see great progress in emerging business opportunities, most notably GenAI development and deployment. In fact, the company recently disclosed that Ernie Bot, China's equivalent of ChatGPT, has attracted more than 100 million subscribers . Needless to say, that represents an enormous monetization base looking into 2024 and beyond.
Meanwhile, market participants price Baidu as a simple advertising business, with shares trading at an EV/EBIT of about 9x. Even accounting for the added risk premium for investing in China-based companies, I argue that such a low multiple is too cheap to justify investors' concerns. In my opinion, Baidu should be worth close to $179/ share to reflect the company's fundamentals. As a function of both business momentum and valuation, I upgrade Baidu stock to a "Strong Buy".
For context, Baidu stock has strongly underperformed YTD versus the U.S. equity market but outperformed China peers. Since the start of the year, Baidu shares are down about 1%, compared to a gain of approximately 25% for both the S&P 500 (SP500) and a loss of 9% for the broader Chinese internet/technology sector ( PGJ ).
Seeking Alpha
Baidu's Ernie Bot May Be As Good And Growing As Fast As ChatGPT
Baidu's CTO Wang Haifeng recently disclosed that Ernie Bot has topped 100 million users. Notably, the successful passing of this milestone comes less than 5 months after the Chinese government allowed citizens' mass access to the technology. Ernie 4.0, which is the latest version of the bot, can handle various GenAi-supported tasks, including text generation, summarization of documents, and code generation. On that note, Baidu has reportedly been working on the technology since 2019 and should support a level of sophistication similar to OpenAI's GPT-4, as claimed by Baidu CEO Robin Li. A similar commentary has been voiced by actual technology testers, with CNN saying :
CNN gave ERNIE and GPT a few simple tasks. The takeaway: You can’t go wrong with either
adding that
ERNIE beat GPT-4 on certain prompts, such as those related to current affairs. The Chinese bot knew that Taylor Swift is now a billionaire , that China had recently removed its defense minister and that “Friends” star Matthew Perry had died.
Overall, I anticipate that artificial intelligence will serve as a crucial growth catalyst for China's internet players and broader economic growth narrative over the next few years. Investors should consider that with increasing life expectancy and declining fertility rates, China's society is aging. This will likely prompt a shift in labor dynamics (lower availability) and accelerate technology adoption (higher need for AI-supported automation and broader productivity improvement).
The fact that Baidu's Ernie Bot has so rapidly expanded its user base to >100 million users highlights China's interest and need for GenAI tools. But despite the enormous jump in users, the Ernie Bot still has lots of whitespace for growth. In fact, currently, only about ~7% of the Chinese population has registered an account with Ernie Bot. But if GenAI as a technology is as foundational as the internet, as often claimed, then the penetration of the Ernie Bot could trend towards ~80% over the next few years.
While the current contribution of AI models to monetization might not be substantial, Baidu has previously tested monetizing the chatbot with a paid version that reportedly costs about $8.4/ month. If Baidu would manage to get 80% of the Chinese population (1.412 billion) to subscribe to a paid version (12 months times $8.4/ month), the company would generate about $114 billion of incremental revenues (compared to the company's market cap of about $41 billion).
Moreover, investors should consider that Baidu is leveraging GenAI (Ernie Bot) to support the company's broader portfolio of applications and software. Specifically, investors should note that Baidu also operates a large Cloud business, with Baidu being the fourth largest cloud vendor in China with approximately 8% market share. Through integrating GenAI capabilities, Baidu should be able to leverage a positive, self-reinforcing feedback loop between the company's Cloud and GenAI business.
Macro And Advertising Profits Likely To Dominate Investor Sentiment In 2024
Baidu's ambition in AI may need about 1-2 years to gain monetization traction. Meanwhile, the company's stock will likely trade in alignment with the broader macro backdrop in China, as well as Baidu's ability to generate earnings through the legacy advertising business. In that context, although China's domestic economic activity remains sluggish, Baidu's operating margins have grown significantly in the trailing twelve months versus FY 2022, with operating income having expanded by approximately 24%.
According to recent macro insights on China, government stabilization policies have so far yielded limited effects on stimulating a sustainable economic recovery post-COVID. The country still grapples with sluggish consumer sentiment, as evidenced by deflationary trends, as well as a broader downturn in the country's real estate market. But overall, I argue that looking into 2024 the risk/ reward for an economic recovery should be skewed to the upside.
Lower Target Price; But Still Upside
I am updating my BIDU valuation framework, reflecting an additional 100 basis point risk premium to account for the amplified regulatory risk. In addition, I revise my EPS estimates to better align my projections with analyst consensus as collected by Refinitiv: I now see Baidu generating EPS of $10.7, $12.1, and $13.9 for 2023, 2024, and 2025, respectively.
Taking these adjustments into account, my calculated fair implied share price for Baidu now estimates $178.99.
Analyst Consensus; Company Financials; Author's Calculations
Below is also the sensitivity table, which tests different assumptions for cost of equity (row) as well as terminal growth rate (column).
Analyst Consensus; Company Financials; Author's Calculations
A Note On Risks
Investors should remain mindful of the risks linked to investing in Baidu stock. Firstly, I point out that the broader sphere of China's internet and tech firms faces considerable exposure to regulatory uncertainties, as seen in recent regulatory announcement that punished the value of Tencent ( OTCPK:TCEHY ) and NetEase ( NTES ) by a cumulative $80 billion market cap loss -- an event that will most certainly rekindle fears of a broader crackdown on tech/ internet companies in China. Secondly, fluctuations in Baidu's stock value are significantly tied to investor sentiment regarding Chinese ADRs and general risk assets, potentially sustaining volatility even if the company's core business remains steady.
Investor Takeaway
Baidu's Ernie Bot has attracted over 100 million users in less than 5 months, indicating strong growth potential for Baidu's GenAI tools in China. Looking to the next few years, the Ernie Bot still has room for growth, with only about 7% of the Chinese population registered. If the Ernie Bot would reach a penetration headroom of approximately 80%, and would achieve full monetization potential on paying users, the company would generate about $114 billion of incremental revenues (just as a reference of the growth potential ahead). Meanwhile, market participants price Baidu as a simple advertising business, with shares trading at an EV/EBIT of about 9x. As a function of both business momentum and valuation, I upgrade Baidu stock to a "Strong Buy".
For further details see:
Baidu: Ernie Bot May Be As Good And Growing As Fast As ChatGPT (Rating Upgrade)