BIDU 2Q16 Earnings: Growth Sputters on Ad Regulations but Still Beat Expectations; Guidance Disappoints

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1 BIDU 2Q16 Earnings: Growth Sputters on Ad Regulations but Still Beat Expectations; Guidance Disappoints Baidu, Inc. Technology Baidu's revenue increased by 10.2% YoY to RMB18.3 billion, while adjusted diluted EPS decreased by 32.6% to US$1.22. The results, while being adversely affected by the new ad regulations, still beat analyst expectations. Adjusted diluted EPS came in 24.5% higher than analyst expectations of US$0.98. Online Marketing Services growth slumps on slowing customer growth and ARPUs. Online marketing revenues only increased by 4.4% YoY compared to 2Q15 s YoY growth of 37.1%. Disappointing guidance as Baidu sees 3Q16 revenues of RMB to RMB billion. This is below current 3Q16 revenue consensus of RMB billion. Despite this, we see 2 bright spots in 2Q16 s results. Adjusted EBITDA margins held at the 23% level, while Baidu s virtual wallet accounts continue to grow strongly. 1

2 Operational Results Revenue and Profits Fall on New Ad Regulations but Results Still Beat Expectations Baidu reported 2Q16 revenues of RMB18.3 billion, up 10.2% YoY, and 16.3% YoY when excluding Qunar (which the Company sold last year). From this, the Company earned an adjusted operating margin of 17.9%, representing a 520 basis point contraction from 2Q15. Adjusted net profit for the quarter was RMB2.81 billion, 30.1% lower YoY, which led to an adjusted diluted EPS of RMB8.08 (US$1.22), 32.6% lower YoY. The results, while drastically lower from the impact of new ad regulations, still beat analyst expectations. Revenue was 0.7% higher than expected, while adjusted diluted EPS beat consensus estimates of US$0.98 by 24.5%. 2

3 Online Marketing Metrics Slump Baidu s life blood remains its online marketing services, and across the board, we see a slump in the segment s KPIs. Online market revenues, which comprise the vast majority of Baidu s revenues, rose 4.4% YoY to RMB16.9 billion. This is a massive drop compared to 2Q15 s YoY growth of 37.1% and just last quarter s YoY growth of 19.3%. Baidu s online marketing customer growth also took a hit from the new regulations. Online marketing customers for 2Q16 was 594,000, 0.7% higher YoY versus YoY growths of 20.9% in 2Q15 and 12.0% in 1Q

4 The sluggish growth in online marketing customers during the quarter was paired with slowing revenue per online marketing customers. 2Q16 registered RMB28,400 in revenues per online marketing customer, 3.6% higher YoY. This is the lowest growth in the metric across five quarters as 2Q15 s YoY growth was 13.2% and 1Q16 s YoY growth was 6.7%. Baidu is experiencing slumping growth not only from the advertising side, but also from the consumer side. In 2Q16, mobile search monthly active users (MAU) was 667 million users, 6% higher YoY. This is far lower than the 24% YoY growth in 2Q15, and also lower than the 9% YoY growth just last quarter. The slowing mobile search MAUs is concerning as this is an important metric for advertisers to decide how much to spend on Baidu s platform. 4

5 Two Bright Spots: Adjusted EBITDA Margins Held Steady, and Baidu Virtual Wallet Accounts Continue to Grow Despite the slowing growth in Baidu s core search and advertising business, there remain two bright spots in the Company s second quarter results. 2Q16 Adjusted EBITDA came in at RMB4.3 billion, 9.7% lower YoY. While the drop in the topline impacted adjusted EBITDA, margins managed to hold steady at the 23.3% level, roughly consistent with previous quarters. Investors were concerned over additional costs Baidu would have to incur from screening advertisements, but it seems the Company managed to keep costs down during the second quarter. A reason for this could be because Baidu only received a partial effect from the ad regulations, as the regulations only came into effect midway through the second quarter. Moving forward, investors will need to monitor this metric carefully as succeeding quarters will bear the full effects of the ad regulations. 5

6 Baidu s virtual wallet accounts continued its strong growth, reaching 80 million users in 2Q16, up 131% YoY. The continued growth in Baidu s wallet accounts is important as the Company seeks to diversify into other ventures outside of its core search business. Disappointing Guidance Full-Year 2016 Consensus Likely to be Lowered For 3Q16, Baidu expects to generate total revenues of RMB18.04 billion to RMB18.58 billion, representing a decrease of 1.9% YoY to an increase of 1.1% YoY. This is approximately 8% lower than current analyst estimates of RMB19.9 billion. The depressed revenue guidance for the third quarter indicates that 6

7 the full year consensus revenue is likely to be lowered. Analysts are currently estimating RMB74.8 billion for FY2016. Assuming 18.3 billion in revenues for 3Q16, Baidu will need to generate RMB22.5 billion in the fourth quarter, 20% higher YoY an unlikely scenario. Baidu will begin to feel the full effects of the new ad regulations in the succeeding quarters as 2Q16 only received a partial effect due to the ad regulations being imposed midway through the second quarter. Conference Call Highlights Management Tries to Calm Investor Fears Suppressed revenue for the next two to three quarters: The implementation of new regulations and the stricter standards that we proactively imposed to make our platform more robust will likely suppress revenue for the next two to three quarters 2Q16 results remind Baidu to focus on user experience: The challenges Baidu faced in the second quarter served as a healthy reminder to stay focused on the key drivers of growth, sustainability and leadership: delivering the best user experience and staying at the forefront of technology Baidu looking to capitalize on artificial intelligence: As we enter the next chapter of the Internet, led by artificial intelligence, Baidu has never been better positioned to serve our users and work with our customers and partners, and change the world through technology. 7