Should You Buy Baidu Inc. After its Post-Earnings Pop?

Shares of Baidu (NASDAQ: BIDU) jumped 5% on Feb. 14 after China's top online search provider reported solid fourth-quarter earnings. Its revenue rose 29% annually to $3.62 billion, narrowly missing estimates by $20 million, but its earnings soared 146% to $2.29 per ADS, beating expectations by $0.19.

Baidu rallied nearly 30% over the past 12 months, compared to the NASDAQ's 25% gain. Therefore, investors might be wondering if they should buy Baidu after its post-earnings pop or wait for a pullback. Let's dig deeper into Baidu's numbers to decide.

What went right for Baidu

Baidu's online marketing revenues, which accounted for 86% of its top line during the quarter, rose 26% annually. This marks a significant acceleration from its 22% growth in the third quarter and 6% growth in the second quarter.

Baidu's total online marketing customers grew 2% annually to 460,000. This represents an impressive reversal from a 7% decline in the third quarter and a 21% drop in the second quarter, which were partly caused by the government-mandated removal of "misleading" ads (mostly for healthcare products).

Baidu's revenue per online marketing customer grew 25% annually to 44,300 RMB ($6,800). This was lower than its 31% jump during the third quarter and 32% increase in the second quarter, but that slight deceleration was easily offset by its growth in total customers.

Baidu also reduced its traffic acquisition costs and bandwidth costs. Traffic acquisition costs accounted for just 10.7% of Baidu's cost of revenues, compared to 14.5% in the prior-year quarter. Bandwidth costs accounted for just 5.9% of its cost of revenues, compared to 6.8% a year earlier.

Those reduced expenses boosted Baidu's non-GAAP operating margin by nine percentage points annually to 24%. Its GAAP operating margin also rose from 12% to 20%. That margin expansion produced a 13% jump in Baidu's non-GAAP net income, as well as a 78% increase in its adjusted EBITDA.

Baidu also provided rosy guidance for the first quarter, with its expectations for 25%-32% sales growth easily topping the consensus estimate of 24% growth.

That estimate is notably based on the new ASC 606 accounting standard, which requires Baidu to exclude value-added taxes from its reported revenues starting this year. Excluding the impact of divested and disposed businesses -- like its mobile games and food delivery unit -- Baidu expects its first-quarter revenue to rise 29%-36%.

What went wrong for Baidu

The only sore spot on Baidu's fourth-quarter report was iQiyi, one of China's biggest video streaming platforms. iQiyi's rising content acquisition costs caused Baidu's total content costs to hit 15.9% of its cost of revenues during the quarter, compared to 14.1% a year earlier.

Those rising expenses reduced Baidu's non-GAAP operating margin by a whopping 12 percentage points for the quarter, but the aforementioned improvements in its traffic acquisition and bandwidth costs offset that decline.

iQiyi's expenses will likely keep climbing as it ramps up its efforts against Tencent (NASDAQOTH: TCEHY) Video, which is roughly tied with iQiyi as China's top video streaming platform.

However, Baidu plans to spin off iQiyi in an IPO later this year. Analysts believe the IPO could raise $1 billion and value iQiyi at up to $10 billion. Baidu plans to retain a majority stake in the new company, but bringing in outside investors would greatly reduce Baidu's financial obligation to iQiyi and significantly strengthen its operating margins.

The road ahead

Analysts expect Baidu's revenue to rise 22% this year, but for its earnings to slip 4% on higher expenses related to iQiyi and its ongoing efforts to counter Tencent in adjacent markets like online-to-offline (O2O) services, fintech, artificial intelligence, and driverless cars.

However, that estimate doesn't factor in iQiyi's IPO, which could significantly improve Baidu's margins later this year. Baidu currently trades at 24 and 20 times its 2018 and 2019 earnings estimates, respectively. Those valuations would likely drop lower if iQiyi's spinoff boosts Baidu's earnings.

I've owned Baidu since last January, and I still think it's one of the essential Chinese tech stocks to own. With solid growth engines, a wide moat, and reasonable valuations, I think that it's still a great buy after its post-earnings pop.

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Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Baidu and Tencent Holdings. The Motley Fool has a disclosure policy.