Baidu Earnings: Lower Fair Value by 5%; Margin and Ad Revenue Headwinds Expected in the Short Term

We lower our fair value estimate by 5% to USD 157 per ADR (HKD 154 per share) from USD 165 (HKD 162) for Baidu after it reported second-quarter 2024 revenue of CNY 33.9 billion, which was in line with our estimate, but suggested that operating margin could be lower in the short term due to the lack of monetization of its ads and weak macroeconomic sentiment. The company expects another quarter of decline for its advertising revenue, and while this was expected in our forecast of a 3% year-on-year revenue decline in third-quarter 2024, we are also lowering our operating margin assumptions by 100-200 basis points in 2024 and 2025. Baidu indicated that advertising softness may hit margin as well given the operating leverage, but we think this is also mainly due to the rollout of its new generative AI ads that the company has yet to monetize. While more search results are incorporating generative artificial intelligence ads, Baidu is prioritizing the client experience for these ads to demonstrate the long-term added value they bring over traditional ads and thus, has yet to begin monetization. We are uncertain when Baidu will begin monetization, but it indicated that a significant percentage, 18% of search results, now incorporate some type of generative AI embedded into it.