Baidu Earnings: Weakness in Ad and Cloud Businesses as Expected but Margin Stability a Positive

We maintain our fair value estimate of USD 183 (HKD 180) after Baidu posted mixed results—core advertising revenue grew 5% year on year in line with our forecasts but with cloud revenue decline of 2%. This was offset by core operating margin of 25%, which increased by 70 basis points sequentially and alleviated concerns that Baidu’s artificial intelligence, or AI, projects would put major pressure on medium-term profitability. Baidu did not provide specific guidance but indicated that next quarter's ad revenue growth should be better than this quarter's and outpace China’s GDP growth—implying a 5%-10% year-on-year increase. It also mentioned that the cloud revenue decline is only temporary. Operating margin increased due to a reduction in operating expenses. Baidu suggested that a 22%-25% operating margin (stock-based expenses excluded) should be maintainable, but that the fourth quarter's should be lower at 21%, due to further AI investments. Management believes that it still has ample room for efficiency improvement and will strive to maintain the current operating margin for 2024. We remain positive on Baidu, given that it maintains a wide moat and dominant market share in China’s search advertising industry.