2023-03-22 10:07:58 ET
Summary
- For many years, I have stayed far away from any investments directly in China. Though, the problem has never been a lack of promising investment opportunities.
- But, I believe that we are at a point where the positives outweigh the negatives, and one could consider initiating a small position due to deglobalization and GDP growth.
- Baidu is my top pick in China and I believe the current valuation is attractive enough for investors to consider buying shares in the company.
- Baidu has a strong growth outlook driven by its exposure and strong position in search, cloud computing, AI, and autonomous driving.
- Baidu will likely be operating the largest robotaxi fleet by the end of 2023, positioning it perfectly to benefit from the expected 50%+ CAGR for the Chinese robotaxi industry.
Introduction - Investing in China is starting to look more appealing
For many years I have stayed far away from any investments directly in China. Though, the problem has never been a lack of promising investment opportunities. The likes of Alibaba ( BABA ), Tencent ( TCEHY ), and Baidu ( BIDU ) have always appealed to me through their excellent competitive offering, all holding impressive market shares in their respective niches. Rather it was the uncertainty tied to the Chinese government that kept me from investing in the country. The Chinese government has shown in the past that it is not scared of intervening in the financial market once something is not to its liking. Just take their actions regarding the IPO of Ant Group as an example. And about 6 months ago there was the threat of Chinese companies getting delisted in the US. This incredible amount of uncertainty is reflected in the 5-year performance of these incredible companies, that did manage to grow revenue at a rapid clip in the same period. Baidu for example is down over 40%, Alibaba is down by close to 60%, and Tencent has not done much better with it down 26%. And we can't blame company performance for this. It is simply been made very tough for these technology giants to operate and grow.
As a result of all this, I decided that I was not going to put my money directly in China. The instability and uncertainty it caused in some of my American and European holdings with exposure to the country were enough for me already. Apple (AAPL), for example, suffered quite a lot from the actions of the Chinese government regarding covid as I described in my coverage of the company .
Yet, by now you will have seen that I am buy-rated on Baidu and the title of this article hints towards me being willing to invest in China despite my negative stance so far, so what changed? I believe that we are at a point where the positives outweigh the negatives, and one could consider initiating a small position. Among these positive factors are the trend of deglobalization, strong GDP growth expectations, and very low valuations.
Deglobalization could turn out to be positive for leading Chinese companies like Tencent, Alibaba, and Baidu with their very strong positions in China and relatively minimal exposure to the rest of the world. And with deglobalization, Chinese companies may face reduced competition from foreign companies in the domestic market, allowing them to expand their market share and increase profits. So deglobalization would simply increase the importance of domestic companies in a country's economy. And we can see it happening all around us. More and more products are made in the same country or continent as consumers prefer domestic products, and companies prefer to be less dependent on foreign countries. The same can be said about governments, proven by the large incentives offered to boost domestic chip production, all to be less dependent on others. This is the first step in deglobalization.
This shift is also already visible among consumer preferences in China. Whereas 85% of Chinese consumers preferred international brands back in 2011, today more than half of these prefer domestic brands in nearly every category, according to a survey by McKinsey . The world economic forum is expecting this trend to continue, driven primarily by enterprises trying to secure themselves from uncertainty, boost business resilience, and mitigate risk. This will increase domestic company importance even more, positioning Chinese tech giants even better with international competition being pushed out.
And it will specifically be Chinese companies that are poised to benefit from the China GDP growth rate expected to remain strong until 2027 as illustrated below.
Chinese GDP growth outlook (Statista)
Moreover, the 4.44% expectation for 2023 looks very conservative as Goldman Sachs recently lifted its China GDP forecast to 6%. Moody's aims for GDP growth of 5% for both 2023 and 2024, showing strong growth expectations as well. This strong GDP growth should very much benefit the domestic tech giants and combined with increasing deglobalization trends, this should be even more so.
And still, I am saying one could "consider" an investment as your decision whether to do this or not could still very much depend on your personal stance towards the China risk. Also, risks have not disappeared. Whereas deglobalization is offering significant benefits to Chinese companies, it is not all positive. Critics warn that deglobalization could lead to a rise in trade wars and a reduction in global economic growth. They also point out that globalization has brought significant benefits, such as increased trade and technological innovation, that could be lost if deglobalization goes too far. And we already have a trade war between the US and China that is impacting Chinese tech companies as these lose access to the highest-end datacenter and AI chips from the likes of Nvidia ( NVDA ) or AMD ( AMD ). Also, political and regulatory risks remain higher in China than in other countries, and there may be limited transparency in some areas of the market. The past 5 years have shown just how risky an investment in China can be, and there is absolutely no guarantee of these issues being resolved today.
Now, with all that out of the way, in this article, I want to discuss one of my favorite Chinese companies - Baidu. I believe the current valuation is attractive enough for investors to consider buying shares in the company and in this article, I will show you why.
So, without further ado, let's dive in!
Baidu, Inc.
Baidu is a leading technology company based in China, that specializes in Internet-related services and products. It was founded in 2000 by Robin Li and has grown to become one of the largest internet companies in China driven by its strong innovation in AI. This is what Baidu itself says about its AI focus:
We are one of the very few companies in the world that offers a full AI stack, encompassing an infrastructure consists of AI chips, deep learning framework, core AI capabilities, such as natural language processing, knowledge graph, speech recognition, computer vision and augmented reality, as well as an open AI platform to facilitate wide application and use. We have put our leading AI capabilities into our products and services, as well as innovative use cases.
Baidu really is a frontrunner when it comes to AI and this is reflected in its strength across several important product categories, including its search engine, cloud products, and autonomous driving technologies, all with AI at the core. With Baidu holding significant market positions in all these high-growth product segments in China, the company looks poised for solid financial growth over the next decade. The markets for three of these leading products are still in their starting phase with the cloud finally taking off after the covid-19 pandemic, AI now much more in the news following ChatGPT, and autonomous driving is perceived as the future in the automotive industry. In addition to this, its incredible strength in search should drive solid cash generation.
Baidu operates the leading search engine in China
Baidu's search engine is the most used search engine in China as it holds a market share across all platforms of 84% . The company's search engine is the primary way that users access Baidu's services and products, including online maps, video streaming, and music streaming. Baidu has continued to invest in its search engine technology, making it more accurate and efficient, and expanding its capabilities to include voice and image searches, driven by AI. This has led to the Baidu Search app reaching over 544 million MAU (Monthly Average Users) in December 2020, illustrating the sheer size of this market.
Baidu's market share in search engine (MarketMeChina)
One of the primary ways that Baidu generates revenue from search is through search advertising. Baidu offers a variety of advertising formats to businesses and advertisers, including paid search ads, display ads, and native ads. To put this into perspective, last quarter, Baidu generated $2.62 billion in advertising revenues stemming from all its apps. Baidu operates a portfolio of over one dozen apps, including Baidu App, Haokan, and Baidu Post.
With Baidu holding a strong position in the Chinese Search engine industry, it is well positioned to benefit from industry growth. And with the global search engine market expected to grow at an 11% CAGR until 2028, this growth is not bad at all. Moreover, this growth in China is expected to be even stronger driven by the increasing number of Chinese consumers with access to mobile devices and an internet connection. As a result, this should drive Baidu's revenue growth derived from its search engine by close to 15% over this period.
In addition to this, the ad spending in the Search Advertising segment in China is expected to grow at an 8.68% CAGR until 2027, according to data from Statista . This, again, shows that Baidu is expected to see strong growth in this segment for the remainder of the decade as a result of its impressive market share.
Baidu is well positioned to leverage its leading AI and cloud strength
Most recently Baidu released its own version of ChatGPT - an AI chatbot with the name Ernie. There was a lot of hype previous to the release of the bot, but Baidu did slightly disappoint with the release itself. First of all, Baidu chose to use pre-recorded video rather than a live demonstration which did not bode well with journalists and investors. CEO Robin Li later stated that the chatbot was seeing some drawbacks as it was used more frequently. But despite this release not causing much enthusiasm, there is plenty of reason to be enthusiastic about Baidu's efforts in AI. Baidu does not need to beat OpenAI's ChatGPT right away. It simply needs to be there and show the Chinese consumers what it is capable of. In the end, ChatGPT is not a competitor as the service is not available in China. The fact that Baidu is the first Chinese company able to launch a functional AI language model is great in itself. This was also confirmed by Bloomberg :
For Baidu, putting out a product with a passing grade is OK. It's not about rivaling ChatGPT on the global stage, which Li admits is a "high bar." It's more about being the first mover in an important market where ChatGPT itself isn't available.
AI has been a leading subject for Baidu for many years already and I believe they are in a good position to make this work. At least they seem to be ahead of the Chinese competition. With the AI market in China expected to double by 2026, according to IDC , Baidu looks poised for strong growth. Baidu is planning to fully integrate conversational AI into all of its products and operations, including search and AI Cloud, over the next couple of years. According to Precedence Research , the global AI industry is expected to grow at a CAGR of 38.1% until 2030, showing plenty of growth ahead.
And one of the product segments from Baidu, besides Search, benefitting from the continued innovation of AI, is the cloud. Baidu seems to be a frontrunner in all high-growth industries and cloud computing is among those as well. Statista data shows an expected CAGR of 22.23% from 2023 to 2027 in the Chinese public cloud market. In addition to this, McKinsey predicts the Chinese cloud market to reach $90 billion in value by 2025 compared to just $32 billion in 2021, reflecting whopping growth. With Baidu holding a 9% market share in the Chinese cloud market, it is very well positioned to benefit from the fast expected growth rates in cloud spending. Also, if Baidu were indeed to stay ahead of the competition in AI and AI cloud, as it is today, I would not be surprised if Baidu were able to increase its cloud market share as well.
China cloud computing market share (China Internet Watch)
Autonomous driving - Baidu is ahead of the competition
In addition to being a Chinese leader in AI, cloud, and search, Baidu is also doing a very good job in autonomous driving where it might even be among the leaders worldwide. As recent as last week, Baidu announced that it received the first-ever permits to provide a fully driverless ride-hailing service in the Chinese capital Beijing. This is extra special as this is the first time that a fully driverless fleet is being deployed in a capital city. And the company also received permits for both Wuhan and Chongqing. As a result, Baidu plans to put an additional 200 fully driverless robotaxis into operation across China in 2023 which would then result in it operating the largest robotaxi fleet in the world.
Baidu has been developing its own autonomous driving technology, called Apollo. The company has been investing in this technology since 2017 and has made significant progress in developing self-driving cars that can navigate complex urban environments. All these years of R&D have resulted in massive amounts of data collected, a crucial part of building a successful self-driving ecosystem. This is highlighted by this news article from PRNewswire :
Baidu has accumulated more than 40 million kilometers of L4 autonomous driving test mileage and 3,477 autonomous driving patent families, holding the world record for number of autonomous driving patents for four consecutive years.
Apollo Go already covers over 10 cities in China and managed to complete more than 474,000 rides in 3Q22 alone which was an increase of 311% YoY, illustrating the massive growth of the service.
And Baidu again leverages its expertise in Ai to both drive the car, but also to increase efficiency and bring down the cost, primarily through Baidu's high precision map production which has now reached 96% . Baidu is developing these high-definition maps that are essential for autonomous driving. These maps provide detailed information about road conditions, lane markings, and other important features that helps self-driving cars navigate safely and also calculate the most cost-effective route. By leveraging AI, Baidu is able to replace humans in working on these maps and bring down the cost-per-ride.
Now, the autonomous driving market is also not like any market, but a highly speculative and high conviction growth market. The Chinese self-driving taxi/robotaxi market size is expected to surpass $188.6 billion by 2030 and will account for over 60% of the Chinese ride-hailing market, according to global consultancy IHS Markit . And according to BloombergNEF's 2022 Electric Vehicle Outlook, this would mean that China will operate the largest robotaxi fleet in the world with an expected 12 million cars by 2040, much bigger than the 7 million car estimation for the US. If that is not convincing enough, then please also consider the prediction by Market Research , which expects the Chinese autonomous market to grow at a 58.9% CAGR between 2021 and 2030, showing an incredible growth rate.
That the Chinese autonomous driving and robotaxi markets are poised for very impressive growth is clear by now, but it is worth mentioning that Baidu is positioning itself to be an industry leader. Baidu is already the robotaxi leader in China and will operate the largest robotaxi fleet in the world by the end of 2023. With expertise in AI, Baidu looks best positioned to keep innovating and bring down prices which will make sure that it will take away even more market share. This is confirmed by an article from Bloomberg that called Baidu the driverless taxi industry leader in an article from early last year.
If you are bullish on the Chinese robotaxi industry (and how can you not be?), then Baidu is your bet to go with.
Outlook & Valuation
2021 was an excellent year for Baidu with rapid growth due to most Chinese people being forced to sit at home due to ongoing covid-19 lockdowns in the country, resulting in them spending more time on the apps of Baidu. 2022 was a much less positive year for the company, though. After reporting flat YoY growth for 4Q22 back in February, Baidu reported a FY22 revenue decline of 1%. But Baidu management now expects to see the business grow again with covid-19 measures now fully out of the way and covid-19 cases dropping.
Following these upbeat comments from the management team, analysts now expect Baidu to report revenue of $19.79 billion for FY23, reflecting a growth rate of 10.28%. For EPS this growth rate is slightly better at 14.33%, resulting in an EPS of $9.78. The reason for a slightly higher EPS is the continued expectation for margin improvement, in part due to a recovery in (high margin) advertising revenue and cost savings.
For the following years, analysts expect Baidu to grow at a similar pace and report revenue growth rates of around 10%, combined with EPS growth of between 10-14%. And honestly, I believe these estimates are somewhat conservative. Based on my research, I expect Baidu to report revenue growth of closer to 12% for FY23 and EPS growth of 17%. For the following years, I believe the growth rates should remain around 10% and 15%, respectively for revenue and EPS, highly depending on the success of AI and autonomous driving products. All in all, the future for the company looks bright with very solid growth expectations.
Revenue estimates (Seeking Alpha) EPS estimates (Seeking Alpha)
So, what does this mean for the valuation? If the company were to operate in the US, I believe it would be trading at a P/E of between 20x and 30x, but since the company and its investors have to deal with the risk of investing in China, the stock currently trades at a forward P/E of 15x which is still 32% below its 5-year average.
Considering the excellent growth rates, products, and exposure of Baidu to multiple secular growth industries, I believe the company should be valued at a P/E of between 18-20x, even when taking into account somewhat of a China discount. As a result, I calculate a price target of $202 based on the current FY24 EPS estimates from analysts and a P/E of 18x. I believe this is still a very conservative price target as I am using very conservative growth projections from analysts and a conservative 18x P/E. Therefore, I believe there is enough downside and risk protection baked into this price target, while still leaving investors with a 34% upside potential from current price levels of around $151.
For comparison, 37 Wall Street analysts currently maintain a price target of $179 per share , combined with a buy rating.
Conclusion
Baidu is a truly impressive company for investors willing to risk an investment directly in China. I believe the positives currently outweigh the negatives for such an investment due to several economic trends benefitting Chinese tech giants, as discussed in my introduction.
Baidu is excellently positioned for strong growth over the remainder of the decade due to its exposure to several high-growth industries like AI, cloud computing, and autonomous driving. Its moat in Search gives it an excellent cash flow to use for further investments and drives a very solid moat for its suite of apps. Also, with Baidu investing in AI for many years already, it looks to be ahead of the Chinese competition on this front which could benefit it significantly and help it gain even more market share in its most important industries like cloud and autonomous driving.
With the stock currently valued below its 5-year average and an improving risk profile, I believe Baidu shares are significantly undervalued today and offer more than 30% upside potential based on very low estimates. Therefore, I believe Baidu is a buy at its current price levels and it offers enough downside protection to lower the risk profile of such an investment.
I rate Baidu a buy on a strong outlook, low valuation, and excellent product exposure.
For further details see:
Baidu: Investing In China Is Starting To Look Attractive Again