Baidu Results Smash Expectations -- Is This a Return to Growth?

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Over the past several quarters, Chinese search giant Baidu, Inc. (NASDAQ: BIDU) has struggled with sweeping changes to comply with new government regulations and weed out unethical advertising practices, causing a significant decline in the number of advertisers for its core search.

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The company had been investing heavily in content for its iQiyi streaming service and the areas of artificial intelligence and autonomous driving. The combination of lower revenue and increased investment weighed heavily on its results, and the stock languished.

Going into its financial results, investors were looking for a return to revenue growth and signs that there was light at the end of the tunnel. Baidu delivered the goods, and investors were not disappointed, with the stock jumping by 10%.

The "search" for growth

Metric

Q2 2017

Q2 2016

Year-Over-Year Change

Revenue

$3.079 billion

$2.748 billion

14.3%

Net Income

$651 million

$363 million

82.9%

Earnings per share

$1.67

$0.99

68.7%

Revenue for the quarter increased 14% year over year, beating investors' expectations and also coming in at the high end of the company's own guidance. Baidu also produced its first increase in profits in three quarters. There were several factors that drove these impressive results.

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The company ended the quarter with 470,000 online advertising customers. While that was a 20.9% decrease from the prior-year quarter, it was a sequential increase of 4% over the most recent quarter. The most exciting development was an average 32% year-over-year revenue increase from each existing customer. That performance follows a trend seen in the previous quarter, when revenue per customer increased 27%. What we're seeing is that Baidu continues to rebuild its pool of advertisers resulting from changes to China's online advertising regulations.

Baidu has reduced spending in other areas, such as online-to-offline, and has integrated its Yelp clone Nuomi into its core operations. These moves resulted in a decrease in operating costs as a percentage of revenue, making the company much more profitable.

Other opportunities accelerate

Baidu significantly increased revenue from its "other services" segment to $441 million, which more than doubled year over year and now accounts for 14% of the company's total revenue. This segment includes its cloud computing services, subscriptions for its iQiyi streaming service, and revenue from its financial services segment. The company does not yet break out revenue within this category, but it reports strong growth in both users and revenue among the three services.

iQiyi has been experiencing rapid growth, with paying subscribers reaching 30 million, a 67% year-over-year increase. During its conference call, Baidu cited data from China's iResearch, indicating iQiyi's PC and mobile app daily active users reached 75 million and 146 million, respectively, and consumed a total of 8.45 billion hours of content. Baidu has been investing heavily in content for its streaming service, with those expenditures amounting to $459 million, or 15% of revenue, in the just-completed quarter. The company believes this could pay huge dividends in the future.

A clear focus on mobile and AI

Baidu reminded investors of its new mission statement "to make a complex world simpler through technology." To that end, the company plans to focus on two strategic pillars: to strengthen its mobile foundation, and to lead in artificial intelligence (AI). Baidu sees AI as a tool to increase the relevance and quality of the other services it offers to users, such as providing more accurate search results. Over the past several quarters, the company used AI to improve conversion rates related to its core search advertising.

Baidu previously announced a move to open-source its self-driving-car project and has since formed a broad alliance of more than 50 partners to advance its autonomous-driving technology. The initiative, titled Project Apollo, is using the Android approach, to open-source and share data among partners, to accelerate innovation and provide compelling long-term economic opportunities for Baidu.

The recent release of its Mobile Baidu version 9.0, was a major overhaul focused on improving the user experience by making the product more mobile-native. This overhaul includes improvements to its individualized news feed, which surpassed 100 million daily active users (DAU), and the company has begun to slowly introduce advertising into the news feed.

These are important developments, as mobile revenue now accounts for 72% of the company's total revenue. Mobile Baidu features its AI-powered DuerOS voice-activated digital assistant, which is tightly integrated into both its core search and news feed and saw the fastest growth in DAU among the top 10 mobile apps in China in the recent quarter. 

The path forward

It looks as if Baidu is finally ready to put the past behind it and return to its previous winning ways. The company is recovering nicely from the events of the previous year and has increased the focus on its core and most promising segments. It previously laid the groundwork for these results, and those moves are starting to pay off.

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