Takeaways From Baidu's Q4 Conference Call
On January 31st, Baidu (BIDU) released their fiscal year 2010 and Q4 2010 numbers to the public. The results were very interesting, and supported the notion that Baidu has significant growth ahead of them.
This is an in depth review of the earnings call from last week. The review will look at the financial numbers posted along with several key takeaways from the executive conference call that will determine the long term success or failure of Baidu in the world of search.
Earnings Report
The earnings that BIDU released last week were excellent. From the press release:
Fourth Quarter and Fiscal Year 2010 Highlights
* Total revenues in the fourth quarter of 2010 were RMB2.451 billion ($371.3 million), a 94.4% increase from the corresponding period in 2009.
* Total revenues in fiscal year 2010 were RMB7.915 billion ($1.199 billion), a 78.0% increase from 2009.
* Operating profit in the fourth quarter of 2010 was RMB1.275 billion ($193.2million), a 175.8% increase from the corresponding period in 2009.
* Operating profit in fiscal year 2010 was RMB3.959 billion ($599.8 million), a 146.7% increase from 2009.
* Net income in the fourth quarter of 2010 was RMB1.161 billion ($175.9 million), a 171.3% increase from the corresponding period in 2009. Diluted earnings per ADS(2) for the fourth quarter of 2010 was RMB3.32 ($0.50); diluted ADS excluding share-based compensation expenses (non-GAAP) for the fourth quarter of 2010 was RMB3.40 ($0.52).
* Net income in fiscal year 2010 was RMB3.525 billion ($534.1 million), a 137.4% increase from 2009. Diluted earnings per ADS for fiscal year 2010 was RMB10.10 ($1.53); diluted ADS excluding share-based compensation expenses (non-GAAP) for fiscal year 2010 was RMB10.36 ($1.57). Costs and expenses related to Baidu’s (BIDU) Japan operations for fiscal year 2010 were RMB182.4 million ($27.6 million), which reduced diluted earnings per ADS by RMB0.49 ($0.07).
*RMB to USD rates of RMB 6.6000 to US $1.00 used to translate these figures
As you can see, the growth is phenomenal again. Quarterly revenue increased 94% with net income growing 171% year over year. The gap between the two reflects a drop in traffic acquisition costs and their continued improvement in better leveraging marketing costs. Their year on year annual growth in net income of 137.4% represents the biggest percentage increase in net income since 2007 and their greatest nominal increase ever. Operating margins were at 52%, not much changes from Q3 2010 operating margin of 52.4% but a healthy increase from 36.7% in 2009. R&D costs have kept pace, hitting almost 70% growth in 2010.
CFO Jennifer Li said that:
Total R&D expenses for 2010 was RMB718 million, a 70% increase from '09, reflecting our continued emphasize on investing in our R&D capabilities.
This is an important part of the earnings release, as it provides a little more comfort that they are taking the next steps towards building and improving their search technology seriously. Guidance for 2011 suggests even higher rates of R&D as they increase their research and engineering staff.
Key Takeaways From the Conference Call
Traffic Acquisition Cost (TAC): Traffic acquisition cost only represented 8.1% of total revenues, as compared with 8.9 in Q3 2010 and 16% in Q4 2009. This decrease has to stop somewhere, and many are inferring that their TAC drops will start to slow as 2011 kicks off. Haoyu Shen could not give a direct answer in the conference call, but he said:
I think TAC ratio should stabilize going forward. We don't give guidance but just look at the TAC numbers. The TAC, the percentage numbers in the past three quarters, those are positive numbers to look at for next year and for this year, 2011.
This being said, as contextual ads become a bigger part of their business, the TAC going up will be offset by the higher price tier of contextual advertisement. When contextual becomes a growth driver, however, remains to be seen.
Small Business Misstep: The sequential growth in active accounts was up only 1.5% compared with 15% and 7% in the second and third quarters respectively. Given this time line, there is a very tangible slowdown in the number of active accounts for Baidu. Simultaneously, spending per account is up 56% from a year ago. This lends itself to the conclusion that Baidu’s clients are getting bigger.
From the conference call, it seems that with the addition of the Phoenix Nest Platform that they are losing touch with some of their small business clients. The technical complexity of the platform is both a boon for sophisticated search and an obstacle for the small business advertiser. Haoyu Shen responded to a question about this in the conference call and said that there was:
Some attrition of smaller advertisers… especially in the early days of Phoenix Nest and [the] other product features we added, they directly benefit the big advertisers… Going forward, we're going to continue our focus on retention and launch product features that will help the small advertisers to improve their experience with Phoenix Nest.
Previously, CEO Robin Li had mentioned something that seemed related to this in regards to 2011. He said:
We will invest aggressively in infrastructure and key hires, especially in R&D, as well as customer and user education campaigns.
The customer and user education campaigns would seem to be a good, albeit late, move in regards to small business difficulty with advertising on Baidu. The CFO maintained that the cyclical nature of the business had more to do with the drop than any sort of burnt bridges with smaller customers. From a business perspective, however, it is easy to see how further saturation of the advertising space on Baidu with big name competitors would move towards squeezing out the smaller advertiser. Their marginal returns decrease as larger companies with more money and recognizable brands are brought in to compete for the same keywords. Despite any promises from Baidu of customer retention programs or user education campaigns, I believe this will be something to keep an eye on in the coming quarters.
Open Application Platform: The open application platform is one of the more intriguing parts of the Baidu business model. They seem ahead of their competitors in this sphere, as apps and games become more pervasive in the lives of the technologically savvy. Google (GOOG), for example, released in browser apps with their latest release of Chrome. However, Robin Li says that Baidu is the:
First general search engine in the world to invert applications in search results with the introduction of Baidu's open application platform… [The] application library has accepted over 2700 application these include not only games but also books, tools and a range of entertainment applications.
This is an exciting time for Baidu as it works towards implementing these applications into their search service. I believe that the presence of such applications can greatly increase user engagement and create compelling switching costs.
Wenku: Baidu unveiled a new document sharing platform that is very comparable to Google Docs. CEO Robin Li said that:
Baidu Wenku, our document sharing platform collect[s] the data and host[s] more than RMB17 million documents now.
However, all is not rosy in the world of Wenku, as reports of rampant piracy and copyright abuse are popping up all over the place. As a compromise on this issue, Baidu has agreed to share ad revenue with copyright holders. They have also pondered launching an upgraded version and charging for downloads. Whatever the decision, it is useless to ignore the fact that Wenku, which is adding over 150,000 documents a day, is not a potential source of growth for Baidu.
Qiyi.com: Qiyi is basically China’s version of Hulu and is a joint venture that only carries licensed content. With the recent IPO of Youku.com, Baidu is wise to investigate online video as an alternative source of income. Robin Li stated that:
Qiyi.com, our online video venture is off to a good start gaining traction on both the user and advertiser front. Just eight months after its launch, the number of unique monthly users has surpassed RMB100 million equating to close to a quarter of all internet users.
Qiyi is a potential source of growth for Baidu but also a point of frustration. A few weeks ago, the Department of Media Organization and Online Programming Supervision of China’s State Administration of Radio, Film and Television (SARFT) decided to investigate Qiyi because they do not have their own Online Audio-Visual Broadcasting License number. Instead, Qiyi uses Baidu’s number. Although the site has yet to be shut down, the inherently unpredictable Chinese government could always push that button.
Additionally, Qiyi has plans to go public. This could be a source of more revenue for Baidu, and a potentially powerful partnership should the site succeed. However, it is a little early to make any bids on the fledgling online media provider, as they aren’t planning to break even on a quarterly basis until 2012. Revenues should be over $100 million in 2014.
Rakuten Joint Venture: This was one of the more surprising moments in the call. I was hoping for some more detailed information about the joint venture with Rakuten, which I go over in my competitive analysis. However, when asked about the venture, Haoyu responded with:
We are fully behind this initiative in the cooperation with Rakuten. But they are really the driver behind the seats so to speak for this joint venture.
I’m not entirely sure how to interpret that. I know that the joint venture is very new, but I really would’ve liked some more explanation of the business intent, progress and partnership in general.
Social Media: Finally, there was talk of social media in the conference call, which clearly tickled investors pink. They said, realizing that social media was in rapid growth outside of mainland China, that Baidu was continuing to build and grow their social presence. Robin mentioned within the first few minutes of the call that:
Since our early days in 2003, we have been evolving our products to integrate search with users' social interactions online. For example, we pioneered a hugely popular query-based discussion forum platform Baidu Post Bar. Our industry leading Q&A platform, Baidu Knows have answered about RMB118 million questions. Today, our social search products like Baidu Post Bar, Baidu Knows, as well as Baidu (inaudible) media are significant drivers of traffic growth and users sticking it… We will continue to invest to further evolve this vibrant social product and integrate them with web search so that users are will increasingly rely on Baidu at the starting point in their online experience.
Robin continued to say that he was very confident about their social position.
When asked if they would continue an external partnership, Li seemed confident they wouldn’t need one, saying:
Our current position in social, I think is already very strong, probably among all the major search engines in the world, we have the strongest social flavor so to speak.
Conclusions
Overall it was a very strong quarter for Baidu. Their Phoenix Nest platform continued to drive customer deposits despite any difficulties encountered by smaller clients. In reality, larger clients will continue to become a larger part of Baidu’s revenue. Retention of smaller customers, while still important, will become decreasingly so as the years progress. I anticipate the combination of myriad projects including Rakuten JV, Qiyi, Wenku and the open application platform will continue to give Baidu different opportunities to grow.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
by Clayton Reeves
This is an in depth review of the earnings call from last week. The review will look at the financial numbers posted along with several key takeaways from the executive conference call that will determine the long term success or failure of Baidu in the world of search.
Earnings Report
The earnings that BIDU released last week were excellent. From the press release:
Fourth Quarter and Fiscal Year 2010 Highlights
* Total revenues in the fourth quarter of 2010 were RMB2.451 billion ($371.3 million), a 94.4% increase from the corresponding period in 2009.
* Total revenues in fiscal year 2010 were RMB7.915 billion ($1.199 billion), a 78.0% increase from 2009.
* Operating profit in the fourth quarter of 2010 was RMB1.275 billion ($193.2million), a 175.8% increase from the corresponding period in 2009.
* Operating profit in fiscal year 2010 was RMB3.959 billion ($599.8 million), a 146.7% increase from 2009.
* Net income in the fourth quarter of 2010 was RMB1.161 billion ($175.9 million), a 171.3% increase from the corresponding period in 2009. Diluted earnings per ADS(2) for the fourth quarter of 2010 was RMB3.32 ($0.50); diluted ADS excluding share-based compensation expenses (non-GAAP) for the fourth quarter of 2010 was RMB3.40 ($0.52).
* Net income in fiscal year 2010 was RMB3.525 billion ($534.1 million), a 137.4% increase from 2009. Diluted earnings per ADS for fiscal year 2010 was RMB10.10 ($1.53); diluted ADS excluding share-based compensation expenses (non-GAAP) for fiscal year 2010 was RMB10.36 ($1.57). Costs and expenses related to Baidu’s (BIDU) Japan operations for fiscal year 2010 were RMB182.4 million ($27.6 million), which reduced diluted earnings per ADS by RMB0.49 ($0.07).
*RMB to USD rates of RMB 6.6000 to US $1.00 used to translate these figures
As you can see, the growth is phenomenal again. Quarterly revenue increased 94% with net income growing 171% year over year. The gap between the two reflects a drop in traffic acquisition costs and their continued improvement in better leveraging marketing costs. Their year on year annual growth in net income of 137.4% represents the biggest percentage increase in net income since 2007 and their greatest nominal increase ever. Operating margins were at 52%, not much changes from Q3 2010 operating margin of 52.4% but a healthy increase from 36.7% in 2009. R&D costs have kept pace, hitting almost 70% growth in 2010.
CFO Jennifer Li said that:
Total R&D expenses for 2010 was RMB718 million, a 70% increase from '09, reflecting our continued emphasize on investing in our R&D capabilities.
This is an important part of the earnings release, as it provides a little more comfort that they are taking the next steps towards building and improving their search technology seriously. Guidance for 2011 suggests even higher rates of R&D as they increase their research and engineering staff.
Key Takeaways From the Conference Call
Traffic Acquisition Cost (TAC): Traffic acquisition cost only represented 8.1% of total revenues, as compared with 8.9 in Q3 2010 and 16% in Q4 2009. This decrease has to stop somewhere, and many are inferring that their TAC drops will start to slow as 2011 kicks off. Haoyu Shen could not give a direct answer in the conference call, but he said:
I think TAC ratio should stabilize going forward. We don't give guidance but just look at the TAC numbers. The TAC, the percentage numbers in the past three quarters, those are positive numbers to look at for next year and for this year, 2011.
This being said, as contextual ads become a bigger part of their business, the TAC going up will be offset by the higher price tier of contextual advertisement. When contextual becomes a growth driver, however, remains to be seen.
Small Business Misstep: The sequential growth in active accounts was up only 1.5% compared with 15% and 7% in the second and third quarters respectively. Given this time line, there is a very tangible slowdown in the number of active accounts for Baidu. Simultaneously, spending per account is up 56% from a year ago. This lends itself to the conclusion that Baidu’s clients are getting bigger.
From the conference call, it seems that with the addition of the Phoenix Nest Platform that they are losing touch with some of their small business clients. The technical complexity of the platform is both a boon for sophisticated search and an obstacle for the small business advertiser. Haoyu Shen responded to a question about this in the conference call and said that there was:
Some attrition of smaller advertisers… especially in the early days of Phoenix Nest and [the] other product features we added, they directly benefit the big advertisers… Going forward, we're going to continue our focus on retention and launch product features that will help the small advertisers to improve their experience with Phoenix Nest.
Previously, CEO Robin Li had mentioned something that seemed related to this in regards to 2011. He said:
We will invest aggressively in infrastructure and key hires, especially in R&D, as well as customer and user education campaigns.
The customer and user education campaigns would seem to be a good, albeit late, move in regards to small business difficulty with advertising on Baidu. The CFO maintained that the cyclical nature of the business had more to do with the drop than any sort of burnt bridges with smaller customers. From a business perspective, however, it is easy to see how further saturation of the advertising space on Baidu with big name competitors would move towards squeezing out the smaller advertiser. Their marginal returns decrease as larger companies with more money and recognizable brands are brought in to compete for the same keywords. Despite any promises from Baidu of customer retention programs or user education campaigns, I believe this will be something to keep an eye on in the coming quarters.
Open Application Platform: The open application platform is one of the more intriguing parts of the Baidu business model. They seem ahead of their competitors in this sphere, as apps and games become more pervasive in the lives of the technologically savvy. Google (GOOG), for example, released in browser apps with their latest release of Chrome. However, Robin Li says that Baidu is the:
First general search engine in the world to invert applications in search results with the introduction of Baidu's open application platform… [The] application library has accepted over 2700 application these include not only games but also books, tools and a range of entertainment applications.
This is an exciting time for Baidu as it works towards implementing these applications into their search service. I believe that the presence of such applications can greatly increase user engagement and create compelling switching costs.
Wenku: Baidu unveiled a new document sharing platform that is very comparable to Google Docs. CEO Robin Li said that:
Baidu Wenku, our document sharing platform collect[s] the data and host[s] more than RMB17 million documents now.
However, all is not rosy in the world of Wenku, as reports of rampant piracy and copyright abuse are popping up all over the place. As a compromise on this issue, Baidu has agreed to share ad revenue with copyright holders. They have also pondered launching an upgraded version and charging for downloads. Whatever the decision, it is useless to ignore the fact that Wenku, which is adding over 150,000 documents a day, is not a potential source of growth for Baidu.
Qiyi.com: Qiyi is basically China’s version of Hulu and is a joint venture that only carries licensed content. With the recent IPO of Youku.com, Baidu is wise to investigate online video as an alternative source of income. Robin Li stated that:
Qiyi.com, our online video venture is off to a good start gaining traction on both the user and advertiser front. Just eight months after its launch, the number of unique monthly users has surpassed RMB100 million equating to close to a quarter of all internet users.
Qiyi is a potential source of growth for Baidu but also a point of frustration. A few weeks ago, the Department of Media Organization and Online Programming Supervision of China’s State Administration of Radio, Film and Television (SARFT) decided to investigate Qiyi because they do not have their own Online Audio-Visual Broadcasting License number. Instead, Qiyi uses Baidu’s number. Although the site has yet to be shut down, the inherently unpredictable Chinese government could always push that button.
Additionally, Qiyi has plans to go public. This could be a source of more revenue for Baidu, and a potentially powerful partnership should the site succeed. However, it is a little early to make any bids on the fledgling online media provider, as they aren’t planning to break even on a quarterly basis until 2012. Revenues should be over $100 million in 2014.
Rakuten Joint Venture: This was one of the more surprising moments in the call. I was hoping for some more detailed information about the joint venture with Rakuten, which I go over in my competitive analysis. However, when asked about the venture, Haoyu responded with:
We are fully behind this initiative in the cooperation with Rakuten. But they are really the driver behind the seats so to speak for this joint venture.
I’m not entirely sure how to interpret that. I know that the joint venture is very new, but I really would’ve liked some more explanation of the business intent, progress and partnership in general.
Social Media: Finally, there was talk of social media in the conference call, which clearly tickled investors pink. They said, realizing that social media was in rapid growth outside of mainland China, that Baidu was continuing to build and grow their social presence. Robin mentioned within the first few minutes of the call that:
Since our early days in 2003, we have been evolving our products to integrate search with users' social interactions online. For example, we pioneered a hugely popular query-based discussion forum platform Baidu Post Bar. Our industry leading Q&A platform, Baidu Knows have answered about RMB118 million questions. Today, our social search products like Baidu Post Bar, Baidu Knows, as well as Baidu (inaudible) media are significant drivers of traffic growth and users sticking it… We will continue to invest to further evolve this vibrant social product and integrate them with web search so that users are will increasingly rely on Baidu at the starting point in their online experience.
Robin continued to say that he was very confident about their social position.
When asked if they would continue an external partnership, Li seemed confident they wouldn’t need one, saying:
Our current position in social, I think is already very strong, probably among all the major search engines in the world, we have the strongest social flavor so to speak.
Conclusions
Overall it was a very strong quarter for Baidu. Their Phoenix Nest platform continued to drive customer deposits despite any difficulties encountered by smaller clients. In reality, larger clients will continue to become a larger part of Baidu’s revenue. Retention of smaller customers, while still important, will become decreasingly so as the years progress. I anticipate the combination of myriad projects including Rakuten JV, Qiyi, Wenku and the open application platform will continue to give Baidu different opportunities to grow.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
by Clayton Reeves
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