Why Baidu Inc. (ADR) Investors Should Be Wary of New Initiatives

By Brian Stoffel Markets Fool.com

For almost a decade, I've been a loyal shareholder of Chinese search engine Baidu (NASDAQ: BIDU). The company's dominant share of search in China, the long-term trend of Internet adoption in the Middle Kingdom, the migration of advertising dollars to digital channels, and a founder/CEO calling the shots who has his skin in the game have long been boons in my mind.

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There's currently a lot of hand-wringing in investment circles over the disappointing performance of Baidu as of late. The stock hasn't gone anywhere in years, revenue is only advancing by the single digits, and profit is falling. But while those things are noteworthy, that's not my primary concern here.

Image source: Getty Images

Instead, I'm far more concerned that focus has been completely abandoned for the Next Shiny Thing. Here's what I mean, and what I plan to do about it.

A company's mission is a window into its soul

While it's admittedly a softer variable, I think evaluating a company's stated mission and vision is crucial for long-term investors. Baidu's mission:"To be the best and most equitable way for people to find what they're looking for."

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I really like that. It's specific in the end result, but broad enough that it leaves multiple futures open to the company. As an investor, I'd like to see the company accomplish this mission by adopting a barbell strategy -- a term pioneered by best-selling author and noted trader Nassim Taleb.

Author formatting, with images from Getty Images.

A barbell strategy works like this: Focus 85% of your time and energy on a safe and reliable form of income. But on the other side, make wild bets on things that -- if successful -- would be game-changers.

The advantages of this strategy are twofold: Any losses incurred by the wild bets would be minimal and offer institutional learning, and any gains from them would be extremely consequential. An example would be Amazon.com's initial foray into web hosting: It was outside of the scope of e-commerce, and it wouldn't have been a killer if unsuccessful, but it has notably contributed to the company's bottom line.

For Baidu, here's what such a strategy would look like: Focus 85% of your time and money on making the mobile advertising ecosystem as strong as possible. Use the other 15% on other projects, like online-to-offline (O2O), artificial intelligence (AI), self-driving cars, and so on. This is essentially what other tech stalwarts such asAlphabet, Microsoft, and Amazon are already doing.

But with Baidu, there's an odd approach

Here's the thing about those three aforementioned stalwarts: While they are experimenting with exciting technologies, the core drivers of the business remain on the safe side of the barbell -- search and advertising, an Office suite, and e-commerce, respectively. And they all continue to grow, often at healthy clips.

Baidu has been pouring lots of money and time into projects that fall well outside its core of search and advertising: O2O services, AI, autonomous driving, video streaming through iQiyi, and even financial services.

Alarmingly, the core base of advertising revenue -- the safe side of the barbell -- has not continued to grow. That's largely because of tighter regulations imposed last year.

Is This Barbell Working?
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Even though "Other" is growing fast, it's nowhere near fast enough to make out for stalled ad growth.

It didn't start out this way. Back in 2012, it was clear the company had to focus on mobile. Founder Robin Li said Baidu was a mobile-first company, and he went out and acquired 91Wireless. Between the end of 2013 and today, mobile revenue has gone from 20% to 70% of all sales.

But the past three years have been truly odd. First, the focus was on O2O, primarily through Nuomi. Li quipped in late 2015 that he should take the listing off the Nasdaq and bring it back to Asia because we didn't understand the potential of O2O. Then it decided to monetize the platform with advertising, instead of taking a small cut of each transaction.

In the most recent earnings release, O2O was barely discussed. Instead, all the attention was paid to AI, and how it would usher in a new wave of products. The problem, as far as I can see, is that the moat AI provides is far narrower than the one provided by Baidu's core business: search.

In between all of this, management hasn't been sure what to make of iQiyi: Should management take it private and off the books, or pour more into content acquisition? All of the additional spending has had a notable effect on the bottom line.

Lots of Spending, Little to Show for It
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Perhaps it's because the other major players in China --Tencent (NASDAQOTH: TCEHY)and Alibaba (NYSE: BABA)-- have been widening their influence, and Baidu is trying to keep up. But again, here's the difference: Tencent remained true to its core of games and social networking, and Alibaba remained true to its core of e-commerce.

As Tech Node recently put it:

Alibaba and Tencent's start-up investment strategy looks like a trawler net fishing,while Baidu seems to be going for precision strikes. However, precision takes time, and the search company has been consistently derided for coming late to the game. For that reason, it has missed chances to capitalize on several waves oftech trends.

And that's really the point. An effective barbell works by being extremely focused on the safe side, and casting a very wide net on the speculative side. Baidu has taken the opposite approach, allowing its focus to wander away from search, while taking very specific bets on the speculative side. While that's OK if the speculative side pays off, it can be disastrous if it doesn't.

What I'm doing about it

As a result, I've decided it's time to pare down my stake in Baidu. Currently, the stock makes up 10% of my real-life holdings. That's too much given the approach that management has taken.

At the same time, I'll still have a significant portion of my assets tied up in the company. That's because I believe a wide moat still exists, there's potential for one of its other pursuits to hit it big, and the migration of ad dollars to digital channels is undeniable.

Investors all need to make decisions for themselves, but I no longer believe this to be a core holding in my own portfolio.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Brian Stoffel owns shares of GOOG, GOOGL, AMZN, and Baidu. The Motley Fool owns shares of and recommends GOOG, GOOGL, AMZN, and Baidu. The Motley Fool has a disclosure policy.