Why Baidu's Results Weren't As Bad As Many Feared

By Danny Vena Markets Fool.com

Baidu, Inc. (NASDAQ: BIDU), the leader in the Chinese online search industry, recently released the financial results for its fourth quarter and year end. The cost to comply with newly enacted Chinese advertising regulations, along with significant investment in research and development, have weighed heavily on its performance, and the company's growth had stalled. While its results looked positively anemic, they could have been worse, and this year will likely be a turning point for the search giant.

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Revenue growth stalled, but...

Growth still appeared to be treading water, but it wasn't as bad as it appeared. Baidu reported quarterly revenue of $2.6 billion, a decrease of 2.6% compared to the prior-year period, while revenue grew 6.3% for the full year. However, investors will recall that in late 2015, Baidu exchanged its majority stake in travel siteQunar Cayman Islands Limited for a 25% stake in Chinese online travel service Ctrip.com International, Ltd. (NASDAQ: CTRP), so these figures are misleading. When Qunar's effect on 2015 results are excluded, revenue for the quarter was flat, and up 11.9% for the year, though still a far cry from the 33% growth the company achieved year over year in 2015.

Baidu may have finally turned the corner. Image source: Baidu, Inc.

The aftermath of stricter regulations

Baidu's active online marketing customers declined 18.6% year over yearas the company worked to overhaul the verification process for its advertisers. The company reported that "some portion of our customer base may not be able to meet our stringent requirements and we may experience a short-term reduction in the number of online active customers." It is essentially weeding out those that used questionable or misleading advertising, particularly in the areas of medicine and tobacco. Going forward, this will result in higher-quality advertisers, and those that remained have been spending more. Revenue per online marketing customer increased 14.2% for the quarter compared to the prior-year period.

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Investing in growth opportunities

Baidu has been investing heavily in areas that it believes will likely produce significant future growth. In its most recent quarter, the company spent approximately $370 million, or 14% of its total revenue on content, and it issued $1.5 billion in convertible notes to grow iQiyi, its subscription video on demand (SVOD) service. iQiyi currently has 480 million monthly active users, though only about 20 million are currently paying subscribers versus those on the ad-supported model. By providing exclusive, high-quality, self-produced content to those who pay, Baidu believes many more will make the switch to paying customers.

Another area that has seen significant investment by the company is online-to-offline (O2O) or transaction services, which matches online customers with merchants.Baidu reported that it reduced SG&A spending by 22% in the quarter, primarily by reducing promotional spending and marketing in O2O, which includes Baidu Deliveries and its restaurant search and rating service, Nuomi.

Spending on content is now 14% of revenue! Data source: Baidu, Inc. Chart by author.

You can't spell Baidu without AI

Baidu has made additional progress toward the fulfillment of its artificial intelligence (AI) agenda. The company recently hired renowned AI expert Dr. Qi Lu as its chief operating officer, as it continues to deploy AI to wider-reaching areas of its business.

The company's artificial neural network, the Baidu Brain, was launched last September and has already been used to realize improvements in its flagship search feature, to promote targeted content for its News Feed, to optimize routes on its Maps app, and to match users with restaurants using Nuomi.

By using AI, the company is able to provide more targeted and relevant advertising and recommendations for matching its users with services. Baidu's digital assistant Duer has been integrated into its voice-activated robot "Little Fish,"its entry into the smarthome speaker market.

Look ma, no hands

Baidu is also aggressively pursuing self-driving car technology, with plans to begin small-scale production of fully autonomous vehicles by 2018, with mass production beginning by 2021.

CEO Robin Li recently revealed that the company will also be seeking to spin off its autonomous vehicle segment in an effort to spur interest and help achieve these somewhat ambitious goals. The company conducted public demonstrations of its technology at the World Internet Conference, providing 200 attendees with real-world test rides in its self-driving cars. This technology could provide significant future revenue streams if the technology is ultimately successful.

Investor takeaway

The last year hasn't been an easy one for Baidu, but the company isn't giving in. It is investing heavily in areas that will not only provide future growth, but make its current businesses more relevant and useful. This isn't the first time Baidu has faced challenges, and I believe it is making the right choices to ensure a bright future.

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Danny Vena owns shares of Baidu. The Motley Fool owns shares of and recommends Baidu. The Motley Fool recommends Ctrip.com International. The Motley Fool has a disclosure policy.