Produced by Hongtu of Radar Finance Written by Xiao Sa Edited by Shen Hai

Like the previous quarter, Baidu's revenue in the second quarter still showed almost no year-on-year growth.

Recently, Baidu disclosed its financial results for the second quarter of 2024, reporting a total revenue of RMB 33.931 billion for the quarter, down from RMB 34.056 billion in the same period last year. Baidu Core revenue was RMB 26.687 billion, up just 1% year-on-year.

This marks the second consecutive quarter that Baidu has underperformed. In the first quarter of this year, the company achieved revenue of RMB 31.513 billion, up 1% year-on-year. Baidu Core revenue for the same period was RMB 23.803 billion, up 4% year-on-year.

During the post-earnings conference call, Baidu's management stated that the company's advertising business is currently under dual pressure from external factors and the transformation of AI-driven search. External challenges include a weak macroeconomic environment and intensified competition, particularly in the real estate, franchising, and automotive sectors.

Furthermore, changes in user behavior have also impacted Baidu's online advertising business. Currently, 18% of search results include generative AI content, but this has yet to be monetized.

In response, Bloomberg Intelligence noted that Baidu's poor performance highlights the challenges it faces in converting its leading position in the generative AI field into significant revenue, as well as the difficulties of transitioning from search advertising to AI amid an economic downturn.

Amid internal and external difficulties, Baidu's share price has returned to 2022 levels after entering the second year of generative AI. Year-to-date, the company's Hong Kong-listed shares have fallen nearly 30%, with market capitalization evaporating by nearly HKD 100 billion.

Revenue growth under pressure

According to Tianyancha data, Baidu was established in 2001 and primarily engages in internet and related services. The company's registered capital is RMB 13.4 billion, exceeding 99% of its peers in Beijing.

During the earnings call following the release of the first-quarter 2024 financial results, Baidu's founder, chairman, and CEO Robin Li stated that 2024 marks the second year of Baidu's transition towards generative AI, and the company is shifting from an internet-centric focus to an AI-first approach.

Li noted that with the advent of the generative AI era in China, foundational models like Wenxin Large Model will become infrastructure, integrating into all aspects of people's lives, presenting new opportunities for Baidu.

However, can the massive investments in AI by tech companies yield returns? At least for now, the returns have not exceeded expectations by a wide margin.

Financial results showed that in the first quarter of this year, Baidu achieved revenue of RMB 31.513 billion, up 1% year-on-year but down 10% quarter-on-quarter from the previous quarter. Net profit attributable to Baidu was RMB 5.448 billion, down 6% year-on-year but up 110% quarter-on-quarter.

Revenue growth slowed to 1%, the first time since the first quarter of last year. According to iFinD data, Baidu's quarterly revenue growth rates from the first to fourth quarters of 2023 were 9.62%, 14.87%, 5.86%, and 5.67%, respectively.

Additionally, Baidu Core revenue in the first quarter was RMB 23.803 billion, up 4% year-on-year but down 13% quarter-on-quarter. Net profit attributable to Baidu Core was RMB 5.15 billion, down 7% year-on-year but up 111% quarter-on-quarter.

Baidu Core primarily comprises online marketing and non-online marketing businesses, with advertising being its primary revenue source. At the time, management explained that the weakness in the advertising business was primarily due to the weak macroeconomic environment. The company's advertisers, mainly small and medium-sized enterprises from various industries, are highly sensitive to the macroeconomic environment. In the first quarter, sentiment among advertisers in vertical sectors such as real estate and franchising remained weak.

This impact persisted into the second quarter. On August 22, Baidu released its unaudited financial report for the second quarter ended June 30, 2024.

The report showed that Baidu achieved revenue of RMB 33.931 billion in the second quarter of 2024, down from RMB 34.056 billion in the same period last year. Under non-GAAP accounting principles, net profit attributable to Baidu decreased by 8% year-on-year to RMB 7.396 billion.

In this quarter, Baidu Core revenue was RMB 26.7 billion, up 1% year-on-year, marking a further slowdown in growth compared to the first quarter. Specifically, online marketing revenue was RMB 19.2 billion, down 2% year-on-year, while non-online marketing revenue was RMB 7.5 billion, up 10% year-on-year, primarily driven by the smart cloud business.

Baidu's non-online marketing business includes revenue from innovative businesses such as smart cloud, Xiaodu, and autonomous driving. Additionally, iQIYI continued its negative growth trend from the first quarter, with revenue down 5% year-on-year.

The primary factor dragging down Baidu Core revenue remains advertising. During the earnings call on August 22, Robin Li acknowledged that the advertising business faces a series of external pressures, including a cautious approach to advertising spending by many small and medium-sized advertisers due to macroeconomic weakness, and users increasingly spending time on a few leading short video and social media platforms.

Some market observers believe that management's statements reinforce market concerns that in a weak consumer environment, offline small and medium-sized businesses often face financial constraints first, which significantly impacts Baidu's advertising revenue as they constitute a large proportion of Baidu's advertiser base.

Regarding the erosion of Baidu's search traffic by short video platforms, this is no longer a new topic. Financial results showed that in June 2024, Baidu App had 703 million monthly active users (MAUs), up 4% year-on-year.

However, according to QuestMobile data, as of June 2024, the number of monthly active users on mobile internet reached 1.235 billion, with 989 million monthly active users on short video platforms, up 3.4% year-on-year. The average monthly usage time per user reached 60.7 hours, making short video platforms the undisputed "online entertainment platforms."

Are AI large models struggling with monetization?

Due to the limited scale of businesses like smart cloud, Baidu still struggles to reduce its reliance on advertising. Amid various external pressures on its advertising business, Baidu pins its hopes on technological innovation.

'We strongly believe that technological innovation will be the key to our future success,' said management. During the earnings call, Baidu spent considerable time highlighting its layout in the AI field.

Specifically, in October last year, Wenxin Large Model evolved to version 4.0. In June this year, Baidu released Wenxin Large Model 4.0 Turbo, claiming it outperforms version 4.0.

Amid the price war in large models, Baidu recently reduced the prices of two flagship models, Wenxin Large Model 3.5 and 4.0, and opened up three models, ERNIE Speed, ERNIE Lite, and ERNIE Tiny, for free access.

Currently, Baidu extensively uses ERNIE to transform its own products, such as Baidu Search and Baidu App (i.e., Baidu's mobile ecosystem), particularly accelerating the pace of using ERNIE to transform search since the second quarter.

The primary goal of this approach is to improve user experience, provide more functions, and increase user engagement on Baidu. When generative AI results satisfy user queries, Baidu recommends other content or services to enhance user dwell time and engagement.

However, in reality, monetization of large models is still in its very early stages, especially in empowering search-based advertising businesses.

Management acknowledged that transforming Baidu Search with ERNIE holds great potential but cannot be achieved in the short term. This process may even negatively impact revenue, 'putting pressure on profit margins in the short term.'

It is reported that currently, 18% of Baidu's search results are provided by generative AI, but this portion has yet to be monetized. While AI-enhanced search products may take time to demonstrate revenue contributions, Baidu is confident in eventually building a more diversified, efficient, and user-friendly AI ecosystem that will drive sustainable revenue growth.

The smart cloud business is a bright spot for Baidu, but the incremental revenue generated by AI is still limited. Currently, revenue related to generative AI accounts for 9% of Baidu Cloud's total revenue. Baidu Cloud is gradually phasing out low-margin businesses, and the company believes that the normalized profit margin for generative AI-related cloud services should be higher than that of traditional cloud services in the long run.

Radar Finance notes that there are detractors of Baidu's AI 'story.' According to iFeng Tech and Bloomberg, the financial report shows that Baidu is struggling to monetize AI and faces difficulties transitioning from search advertising to AI as a revenue source.

Meanwhile, Baidu's autonomous driving business, which is gaining momentum, is still in the 'burning money' stage. According to iMedia Research analysts, amid fierce global competition in the autonomous driving market, Luobo Express is expected to achieve break-even in Wuhan by the end of 2024 and enter profitability in 2025.

Share price down nearly 30% year-to-date

With stagnant revenue, Baidu's profitability is also far from optimistic.

In the second quarter of this year, net profit attributable to Baidu was RMB 5.488 billion, up 5% year-on-year. However, under non-GAAP accounting principles, net profit attributable to Baidu decreased by 8% year-on-year to RMB 7.396 billion.

Excluding the impact of iQIYI's business in the financial report, net profit attributable to Baidu Core was RMB 5.462 billion, up 9% year-on-year. Under non-GAAP accounting principles, net profit attributable to Baidu Core was RMB 7.29 billion, down 5% year-on-year.

First Shanghai Securities Research believes that Baidu's second-quarter revenue was slightly below market expectations, while profit exceeded expectations, primarily due to cost optimization.

From the financial report, Baidu vigorously optimized costs in this quarter, with both R&D expenses and sales and channel management expenses decreasing. Specifically, sales and administrative expenses decreased by 9% year-on-year, and R&D expenses decreased by 8% year-on-year, due to factors such as expected credit losses, channel expenses, and marketing costs, as well as reduced personnel-related expenses.

Wu Liuyan, an analyst at Kaiyuan Securities, believes that while Baidu continues to face pressure on the revenue side pending AI monetization, its profitability is more secure. The steady profit margin of the AI cloud business is expected to be higher than that of traditional businesses. With a focus on achieving break-even in key regions for intelligent driving, reducing investment in non-core businesses and optimizing expenses, the profit margin is expected to remain stable.

However, Baidu's profit-first strategy seems unable to appease institutional investors. First Shanghai Securities noted in its research report that Baidu faces pressure in the second half of the year due to economic uncertainty and the uncommercialized AI search. The long-term erosion of traffic continues, significantly impacted by short video platforms. Baidu's C-end AI user penetration lags behind, with slowing growth, and the effectiveness of AI-assisted search advertising remains questionable.

Additionally, while the company has ample cash, its share repurchases have been insufficient. Considering macroeconomic pressures, traffic competition, and difficulties in AI monetization, the institution downgraded Baidu's target price to HKD 107 and maintained a 'Buy' rating.

Following the earnings announcement, Goldman Sachs also downgraded Baidu's target price from HKD 141 to HKD 127, maintaining a 'Buy' rating. The bank reduced its revenue forecast for Baidu from this year to 2026 by 2%, reflecting downward adjustments to advertising revenue projections. Net profit projections were increased by up to 1%, reflecting the company's ongoing operating expenses.

The bank also downgraded its forward P/E target for Baidu's core advertising business to 7x, reflecting a delayed recovery in online advertising, lower monetization potential for generative AI search, and weaker macroeconomic conditions.

As of the close on August 28, Baidu's Hong Kong-listed shares closed at HKD 81.9, down 3.19% for the day, with a total market capitalization of HKD 229.7 billion. The share price has approached its low in 2022. Based on this calculation, Baidu's share price has fallen by 29.46% year-to-date, with a market value erosion of HKD 95.939 billion.