Investing In Baidu To Bet On Artificial Intelligence – Seeking Alpha

Baidu (NASDAQ:BIDU) is one of the main companies that are trying to build a strong position in the promising market of artificial intelligence. In this article, I explain why I think investing in Baidu can be also a good way to gain exposure to AI. Artificial Intelligence offers a large number of functions that can strengthen Baidu's current businesses, but also gives the company the possiblity to exploit "new" markets such as autonomous driving and AI applications for financial services and healthcare.

The situation

I have been long Baidu more or less for 3 quarters but the stock hasn't gained much since I started my position. The market is still scared by the weak performance of the company's non-core divisions, while the recent need to adjust advertising practices has weighed on sales in the short-term. The core search market, despite a rise in revenue per customer, suffered from a reduction in the number of customers as a result of stricter regulations for online advertising.

While fundamentals remain very strong in the core search business, the market questions the company's ability to lead its non-core divisions to profitability.

The stock has gone nowhere for the last two years and while I believe it's one of the best large-caps stocks to hold for the long-term, I understand some of the market's doubt about Baidu's non-core divisions. ITE keeps reporting huge operating losses due to the rising content costs and the company's apparent desire to gain a scale advantage that could help them reinforce their leading position. I would love to see the division turn profitable, but I understand the strategy and I support it. As I wrote in a recent article:

I understand the company's investment in content for ITE, because I understand that a leading position in this business is the best factor for growth. The reason is that the economics of this business are basically the same of Pay-TV, which has already shown in many countries that the market leader has a clear advantage over the others and usually reports much better margins and a more stable growth than competitors. Trying to create a size advantage is probably the best strategy now.

On the other side, I am more disappointed by the results in the transaction services division, where I expected a faster growth and a constant decline in operating losses. Markets would love a sale of the division, but I think it's an unlikely scenario. Management has always considered Transaction Services as an integral and important part of the company's core business while CEO Robin Li once estimated the Chinese O2O market to be worth $1.6 trillion, which would mean the company is just starting to scratch the surface of this market.

The summary is that we have a strong core search business that will be back to growth soon, as the effects of the new regulation are mostly gone, while there are still some doubts on Baidu's non-core divisions, as the strong revenue growth is being constantly neutralized by rising operating expenses.

I am long because I think Baidu's growth prospects are still bright, despite the current losses in non-core divisions. After all, the company is a leader in basically all the three segments of Search, O2O services and subscription-based online videos. Baidu has still a lot of growth ahead, thanks to the positive trend in internet consumption in China.

Artificial Intelligence

One of the sectors where Baidu has been particularly active in the recent past is Artificial Intelligence. Artificial intelligence is one of the fastest-growing industries and expected to transform the way we conduct our lives and do business as the Industrial Revolution did in the 18th and 19th century. We know that AI functions are currently used in videogames, automatic language translators, self-driving cars, social networks and web-based advertisements, to name a few.

Baidu is also integrating AI in basically all of its businesses. Launched in September, Baidu's artificial intelligence platform "Baidu Brain" is already deployed across segments such as Search, News Feed, Maps, Nuomi, and PostBar, to name a few. As CEO Robin Li declared:

Users experience the magic of AI when they use Voice and Image Search or when we push targeted content in News Feed, recommend dishes in Nuomi, optimize a route in Maps, or intelligently suggest video content on PostBar. With AI, we are able to better match and predict user intent and deliver results that are more relevant and more targeted.

Besides those applications, AI can be employed in areas such as cloud, financial services and autonomous cars. Baidu's plan to become an important player in autonomous driving are known. The company is involved in a partnership with Nvidia (NASDAQ:NVDA) to develop a computing platform for self-driving cars and has recently announced it plans to start mass producing autonomous cars in five years.

Baidu has already started to test its vehicles in partnership with BMW (OTCPK:BMWYY) and Chinese automakers BYD, Chery and BAIC, although the partnership with BMW was terminated in November because "the development pace and the ideas of the two companies are a little different".

I think the company's prospects in the autonomous car market are bright. Baidu has a strong position in China and can leverage its knowledge in AI, machine learning and mapping to grow in the autonomous car market, which is particularly promising in the region. There's a large opportunity for autonomous vehicles in China, as the country has many cities, such as Beijing and Shanghai, where there is a high concentration of low- to middle-income individuals, who often are not wealthy enough to buy a car and would prefer to rely on an autonomous ride-hailing service for mobility. In 2015 , a World Economic Forum study found that 3 quarters of Chinese would be willing to use a self-driving car, suggesting a huge market for a ride-hailing service. The potential market size is huge, but we should keep our eyes on future developments, as competing in this industry against giants such as Apple and Alphabet won't be easy.

Autonomous driving is not the only "segment" where Baidu is trying to grow. More recently, Baidu started to use AI applications in the financial services market where AI is employed in risk-control techniques including facial and fingerprint recognition, liveliness detection and optical character recognition of identification documents.

AI applications are very useful in the healthcare sector as well. Back in October, the company launched a medical chatbot designed to make diagnosing illnesses easier. Ceo Robin Li said that AI is able to "redefine" the health care industry. He believes that artificial intelligence can be used in fields such as genetic testing or even in developing and testing of new medicines. There are many applications for AI in this space. For example, IBM Watson can analyze healthcare invoices and tell if a doctor, clinic or hospital makes mistakes repetitively in treating a condition, in order to help hospitals and doctors improve and avoid unnecessary hospitalizations of patients. Some more advanced "services" include those offered by Human Longevity, a young enterprise that offers its customers the possibility to complete genome sequencing, body scan and detailed check-ups in order to detect cancer or vascular diseases in their very early stage.

It's clear that AI can be a great thing for Baidu for two reasons:

1 - It can be easily integrated with Baidu's current businesses, improving the quality of its current services. For example, Baidu is using AI application to improve user experience in its search business, where voice-recognition can make online searches more practical. At the same time, customers are reached by targeted content in News Feed, by restaurant and retail suggestions in Nuomi, and by suggested video content on Postbar.

2 - AI offers Baidu the possibility to enter new markets, with autonomous driving being the main one. Autonomous driving is expected to be one of the main growth industries of the future. Estimates are very difficult at this stage and the institutions that tried to do so offered different scenarios. Nonetheless, they all forecast huge growth in the next 10-25 years. For example, the IEEE (Institute of Electrical and Electronics Engineers) estimated that up to 75% of cars in 2040 will be autonomous, while IHS automotive predicted that autonomous cars in 2035 will be 21 million. The Boston Consulting Group has more conservative expectations, forecasting that in 2035 there will be 18 million autonomous vehicles. In any case, the potential market size is huge.

The idea that investing in Baidu is a good way to bet on Artificial Intelligence is a result of a few considerations. As I said, the company can benefit from the growth in AI in two ways. It will have the possibility to exploit new markets such as autonomous driving and AI applications for financial services or healthcare. At the same time AI will strengthen its current business divisions by improving user experience. I see an investment in Baidu as a "conservative" bet on AI. Baidu already has good growth prospects in the core search business and the two underpenetrated markets of transaction services and subscription-based online videos, and AI applications can only strengthen those segments further. On the other side, the current investments in autonomous cars and other uncorrelated segments can be valuable options for long-term growth.

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Disclosure: I am/we are long BIDU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Investing In Baidu To Bet On Artificial Intelligence - Seeking Alpha