Baidu: Lift the ban on ads and increase AI investment (summary)

Below is the content of Baidu's Q3 2022 earnings conference call. For financial report interpretation, please refer to "Baidu: Valuation is Mostly Cash, What is the Market Still Afraid of?".

I. Core Highlights:

1. In the coming quarters, the demand for travel and local-service ads, which are most affected by lockdowns, is expected to rebound strongly. During this time, the company will generate good advertising revenue and recover its year-on-year growth in advertising revenue.
2. The physical economy, local services, commercial services, travel services, etc. have been greatly affected by the pandemic. When the pandemic's effects gradually weaken, the demand for advertising will quickly rebound.
3. The company will continue to invest in new AI businesses and allocate a large proportion of funds from the cash flow generated by mobile ecosystem businesses into new AI businesses. At the same time, the investment in new AI businesses has not had a negative impact on its financial performance. The company will not consider the impact of these investments on its performance in the short term and hopes that these areas will all reap good profits in the future.

II. Management Remarks

1. Overall Performance

Despite the ongoing challenges posed by the COVID-19 pandemic, Baidu's core business recorded robust financial and operational performance in Q3. Core revenue had recovered and achieved positive year-on-year growth, driven in part by the gradual recovery of its online marketing business and steady growth in intelligent cloud revenue.

It is worth noting that the company continued to make significant breakthroughs in the intelligent driving business sector. On the one hand, Baidu Apollo's automotive solutions continue to gain recognition from leading automakers. On the other hand, its autonomous-vehicle ride-hailing service, Luobo Kuaipao, has continued to expand its operations. In this quarter, it supplied over 474,000 orders, further consolidating its leading position in the global autonomous driving market.

Looking ahead, it is expected that the mobile ecosystem will continue to generate strong cash flow, providing funds for the investment in intelligent cloud and intelligent driving businesses. This will strengthen the leading position of the company's new AI business and drive future growth.

2. Business Performance by Division

2.1 AI business

ACE Intelligent Traffic Solution: As of the end of Q3, the ACE intelligent traffic solution has been implemented in 63 cities, with the total contract amount exceeding RMB 10 million, compared with 24 cities in the same period last year. The solution has been deployed in cities such as Beijing, Guangzhou, Shanghai, and Chongqing to improve local traffic efficiency; and Zhuzhou, Hunan, has also decided to adopt the ACE intelligent traffic solution.

The ACE intelligent traffic solution is conducive to improving transportation operation efficiency and solving mature pollution problems. The cooperation between Baidu and cities is a win-win situation. On the one hand, it can provide better motivation for urban development, and on the other hand, it can push the solution to more cities.

Apollo intelligent driving solution (ANP+AVP+ high-precision map): The solution has gained more recognition from whole vehicle manufacturers, and Baidu hopes to integrate it into their models. The company hopes to continue such cooperation, and their willingness to cooperate also proves that the Apollo intelligent driving service is gradually maturing. A few months ago, Baidu Maps were completely integrated into intelligent driving. It's worth emphasizing that the company is committed to investing in intelligent driving and has seen initial results from its investments. Currently, the policies are favorable for the development of intelligent driving. It is expected that after the deployment of the intelligent driving solution, the total cumulative sales will exceed 11.4 billion yuan. In the second half of the year, models equipped with the Apollo intelligent driving solution will be launched, and the Apollo intelligent driving solution will begin to contribute revenue in 2024.

Regarding Robo-Taxi: Q3 saw a record-breaking 477,000 orders for self-driving rides, a YoY increase of 300% and an MoM increase of 65%. As of the end of Q3, more than 1.4 million self-driving service orders were provided to users.

In the future, we hope to cover more areas of the city during peak hours, such as subway stations, office buildings, and shopping centers.

On the technology front, as the business continues to expand and launches in more cities, our operations will collect more data to better understand different scenarios and optimize the self-driving solution.

Regarding safety, we will further expand Level 4 autonomous driving, serving more scenarios and users. AI driving can definitely outperform human drivers, and can provide a better riding experience for users in extreme weather conditions. The increase in operating data can also enable better handling of extreme or edge cases.

Overall, as the performance and safety of the service improve, self-driving will become the ultimate solution for urban transportation.

Regarding AI Cloud, we hope it can achieve long-term sustainable development and continuously implement measures to standardize the solution to serve more industries and reduce deployment costs.

The company hopes to empower more industries through AI, such as traditional manufacturing, public facilities, energy, and government departments that are lagging behind in digital transformation, to achieve their digital and intelligent transformation, improve productivity, and control costs.

The potential of the future market is huge. The company has a full-stack AI solution (deep learning framework, large language models, application-level software) and a deep understanding of user pain points. Analysis of user needs will also help optimize and improve the solution. In the currently unfavorable macro environment, project implementation has been delayed, but as the environment gradually improves, these projects will be advanced.

Overall, the trend of digital and intelligent transformation is firm, and the company is committed to high-quality growth, improving profitability, and achieving the high-quality profit-making capability of AI Cloud.

Regarding the mobile ecosystem business: In Q3, the profit margin improved significantly YoY and generated strong cash flow, and the mobile ecosystem is continuing to expand.

(1) User ecology: In September, the daily active users of the Baidu App reached 634 million, a YoY increase of 5%.

(2) Advertising: In Q3, the total mobile search query volume increased by double digits, and the total feed ads served in the Baidu App increased by 23% YoY. The company will continue to introduce more short videos in feed and search results. In September, short videos were further distributed in Baidu's information flow, with the users' staying time increasing by double digits compared to the previous year, and it is expected to account for a larger proportion in search. In addition, more short videos will be made for the mobile ecosystem. Currently, these works are still in the early stages, and it is believed that AI will bring more possibilities for generating high-quality content and quickly aggregating videos while reducing costs.

Although the advertising industry has been severely impacted in the past few years, many vertical fields have a strong demand for advertising when the economy improves.

(3) E-commerce: In terms of e-commerce, user search growth exceeds 52%. Users not only search for information and knowledge on Baidu, but also more services and products. If there is a purchase link attached, they will directly generate purchase behavior. The company hopes that more users will complete more online activities in the mobile ecosystem to accumulate more user insights to better serve users. On one side is user search, and on the other side is the product service provider. The company analyzes the demand on both sides to improve the user experience.

3. Summary

Although the current environment is not ideal, Baidu's performance in the past few quarters has been good. Futuristically, more investments will be continued with additional focus on increasing investments in new AI businesses. A considerable amount of capital will be invested in the new AI business from the cash flow of the mobile ecosystem business. In the short term, the new AI business has shown very good development momentum, and it will make more revenue and profits for Baidu in the future.

Analyst Q&A

I. Advertisement

Q: As the pandemic gradually fades away, what is the expected recovery situation for future advertising demands?

A: Under the cost control measures for the past few quarters, the Q3 advertising business has improved significantly compared to Q2.

The situation in Q2 was very bad, and the lockdown prevented many businesses from operating. Although the epidemic improved significantly in October, it struck back in places like Guangzhou and Beijing in November. The company is constantly monitoring the epidemic. There is obvious uncertainty in the short term, but in the medium and long term, there will definitely be some improvements. Overall, the pandemic is slowly fading away.

In the coming quarters, travel and local service ad demands that were hit hardest under the lockdown are expected to rebound strongly. At that time, the company will generate good advertising revenue and recover advertising revenue's year-on-year (YoY) positive growth. In addition, the new AI business has also been negatively impacted by the pandemic, but the current impact is gradually diminishing.

Q: What is the competitive situation of China's online advertising market?

A: China's mobile Internet is developing fiercely, and advertisers are very sensitive to their advertising return on investment (ROI) and hope to achieve good advertising effects. In terms of the company's advertising services, after the user actively enters keywords in the search box, better products and services can be returned and the advertising effect is very good. Therefore, many advertisers believe that Baidu search is the most effective and important advertising channel, helping them better reach their target audience.

Although China's mobile Internet is developing rapidly, it has not yet reached complete maturity. In the past few years, user growth has gradually slowed down, and the industry is gradually maturing. The competition is stabilizing and the big players in the industry have basically determined their advantages. Against this backdrop, Baidu App has successfully gained recognition from numerous users, signifying its strength. The company hopes to provide users with more relevant information through search and provide advertisers with the most effective user reaching method. Small and medium-sized enterprises (SMEs) advertising have performed very well. Local services, commercial services, and travel services in the real economy have been greatly affected by the epidemic. After the epidemic's impact gradually weakens, advertising demand will rebound rapidly. In contrast to the short-term rebound in advertising demand, what is more important to emphasize is that Baidu has strong appeal to advertisers in different vertical fields.

II. E-commerce

Q: How to build better and more accurate connections between buyers and sellers in e-commerce?

A: (1) E-commerce

In terms of e-commerce, the company has always been committed to building a closed loop experience for users and advertisers in the mobile ecosystem. On the Baidu App, users can search for keywords, obtain relevant product and service information, and make purchases. The closed loop is reflected in the fact that users tend to use the Baidu platform because the platform can provide detailed information, while advertisers are more willing to choose the Baidu platform due to the large number of users. E-commerce has great potential: in the past few quarters, Baidu's e-commerce sales have been on the rise; during the Double Eleven period, sales in many vertical areas increased significantly, with a year-on-year growth rate of over ten percent.

(2) Short-video.

In terms of short video, there will be more and more short videos appearing in search and information streams. In the information stream, the distribution of short videos is gradually increasing, and the time users spend on short videos is also steadily increasing. About 80% of the distribution is achieved through the Baidu App, and the remaining 20% is achieved through click search. In September, the year-on-year growth rate of short video distribution and viewing was over 80%, and we believe that the popularity and viewing rate of short videos in search will continue to rise.

The monetization of short videos focuses on providing users with an immersive short video experience, which is actually a content form that is superior to text and pictures. In Q3, short videos were one of the keywords that the company focused on, which helps to increase search-related revenue. Despite the unfavorable macro environment, the development of short videos in Q3 was very good. Currently, the company is trying to use AI to generate rich short video ecology. It is still in the early stage at present, and AI will generate a large number of short videos at a faster rate and lower cost in the future.

(3) Data interconnection.

In addition, data interconnection between different platforms is also very important. Interconnection can benefit more stakeholders. In the long run, the government is willing to promote higher levels of interconnection between Internet platforms, which will benefit the development of e-commerce and other industries.

Overall, e-commerce and short videos are the primary focus of the mobile ecosystem, and future efforts will continue to focus on these two areas. Profit growth will be very considerable.

III. New AI Business

Q: What are the advantages of Luobo Kuai Pao in competition? What do you think of the car manufacturers developing their own intelligent driving solutions?

A: (1) Status quo

In the first ten months of 2022, the company's intelligent driving solution sales grew by more than 100%.

China's electric vehicle market is developing rapidly, currently the largest electric vehicle market in the world, accounting for more than 50% of global sales, and Baidu is benefiting from these trends. The company began investing in autonomous driving many years ago, and the Apollo solution is based on long-term technology accumulation. Currently, many AI models have been established for autonomous taxis, and these models can also be applied to other related solutions. The company has collected a lot of operating data on urban roads, hoping to strengthen insights into the market and user needs, and further develop better automotive solutions. Competitive advantages

Firstly, currently, Dolphin has the most advanced urban road intelligent driving solution, and L4 level autonomous driving is gradually achieving. If fully realized, it can provide safer and more efficient travel services for more scenarios.

Secondly, more and more automakers are starting to use the company's solution, which is conducive to improving the company's experience in solution and vehicle compatibility. The company hopes that more automakers will introduce solutions to collect more data for model training, improve the intelligence of the solution, and respond to more edge cases. In the future, the company will continue to collect data. If Dolphin can be deployed in more cities, it is expected to contribute revenue starting in 2024.

In addition, the company has made a lot of investments in this field, which many companies cannot afford. Automakers trust Baidu's brand and technology (ANP, AVP, high-precision maps) and choose to develop intelligent solutions with Baidu. At present, the company has invested in intelligent driving for many years, and its cash position is very good. The mobile ecological advertising business has also generated strong cash flow support for continuous investment.

Q: Expectations for the future development of Dolphin and its impact on cash flow and profitability

A: (1) Business development of Dolphin

Currently, it is in a leading position in unmanned driving travel services and has been deployed in cities such as Beijing, Shanghai, Guangzhou, etc., providing lane and heading services in Wuhan and Chongqing. Dolphin has deployed in more than 10 cities, covering a urban population of over 10 million. In the future, the company will further improve its technology and safety. In terms of technology, it hopes to provide users with the best experience at any stage of ordering, boarding and arriving at their destination by simplifying procedures such as startup operations. Currently, it has won the recognition of many users. In terms of safety, Dolphin's vehicles always obey traffic rules and have excellent performance in active and passive speed control.

Currently, the operation of Dolphin in Chongqing and Wuhan is progressing very smoothly and will be gradually promoted according to the current plan. In 2023 and beyond, the company will promote Dolphin to more cities, further reduce hardware and vehicle costs, and ultimately achieve strong profitability. Currently, Dolphin is expanding very fast, and with the reduction of costs and increasing orders, it will soon achieve good revenue and profits.

In the past few quarters, the company has been collecting data in different cities, hoping to improve technology through large-scale operations. For example, in Wuhan and Chongqing, we have communicated with many users, and the overall feedback is very positive. Unmanned driving technology is accepted by many users, and such initiatives will be further promoted in the future. In fact, after canceling the safety officer in the vehicle, there is more space for passengers, which can enhance the user's riding experience. As for hardware, there will be new adjustments for new vehicles in the next 12 months. Next year, the company will further invest more money in developing this business. Eventually, Dolphin will contribute positively to financial data.

(2) Cash flow

Overall, it is very healthy. The company has internal models for autonomous driving and cash flow analysis, and is gradually optimizing and adjusting cash flow. (3) Cost

The elimination of onboard safety officers has reduced labor costs. In the future, hardware and vehicle costs will gradually decrease.

4. Business as a whole

Q: Headwinds in Baidu's business development; growth rates of different businesses; market share and growth trend of AI cloud business

A: (1) Impact of the pandemic

The impact of the pandemic has been very clear over the past few quarters. As China's epidemic prevention and control work advances, the impact will become smaller and smaller. The company has always focused on long-term and more sustainable growth, and the impact of the pandemic will not exist for a long time. Focusing on the long term, we will continue to promote cost reduction and efficiency improvement, and optimize low-profit business.

(2) Different business segments

In terms of advertising, Baidu App has a strong appeal to advertisers in different verticals.

In AI cloud, public utilities, government departments, manufacturing and other sectors are in great need of AI capability. The company hopes to transfer the businesses of these industries to the cloud, without requiring users to change any of their habits. The company hopes to further communicate with these industries after the pandemic to enhance their confidence in AI cloud businesses. In fact, during the pandemic, many companies have recognized the importance of digital and intelligent upgrades; after the pandemic, it is expected that many companies will spend money directly on relevant deployments.

In ACE Smart Transportation, it has grown rapidly, gained a large market share, and gradually reduced operating losses. It is constantly enhancing its capabilities to make its operating leverage healthier. In the future, the company will learn from more project deployments. Specifically, data is very important. This is a virtuous cycle, and data helps to improve solutions better, while the deployment of solutions can provide more data.

Overall, the company hopes that each business segment can fully leverage its competitive advantages and capture market opportunities. The company will increase investment in each business segment and enhance profitability. In particular, in the AI cloud business, the operating loss has been narrowing, and the operating loss rate continues to decrease. It is expected to have considerable performance in the future. At the same time, the company is striving to standardize and replicate solutions to reduce deployment costs and improve deployment efficiency.

Q: The space for further cost reduction for Baidu's core in Q4 and 2023, and future profit margin expectations; If the macro environment deteriorates, will investment in the field of self-driving vehicles slow down?

A: The company continues to optimize its cost structure and is considering how to better promote cost reduction and efficiency improvement in the future.

To achieve better growth in the future, the company has been investing in new AI businesses, and this strategy is very determined. The company believes that new AI businesses will definitely contribute a considerable amount of revenue and contribution in the future. At the same time, investment in new AI businesses has not had a negative impact on financial performance. The company will not consider the impact of these investments on performance in the short term, and hopes that these areas will harvest good profits in the future. Specifically:

The operating profit margin for this quarter was 26%, an increase from 24% in the same period last year, indicating that the measures taken are effective and the investment direction is very correct, and it has not affected key financial indicators. Based on strict control of channel expenses and promotion costs, sales and administrative expenses have further decreased for three consecutive quarters on a year-on-year basis. In the future, the company will review business dynamics and continue to control variable costs and expenses. Although the epidemic has brought many adverse factors, its impact on the company has been reduced this quarter, and many business sectors have seen year-on-year and month-on-month improvement. In the future, the company will reduce its investment in long-term low-profit businesses and allocate more funds and resources to high-profit businesses. The company will firmly invest in new AI businesses, and the investment will be substantial.

Intelligent transportation can effectively drive the development of smart cities, making cities more intelligent, reducing traffic congestion and emissions. In the future, the company will establish cooperative relationships with more cities, deploy ACE intelligent transportation solutions for them, and closely monitor investment and cash flow. The company's strategy is to strengthen its leading position in this field globally. Currently, the RoboTaxi driverless taxi is in an absolute leading position, with a considerable market share, and has been deployed in many key cities in China. In addition, vehicle manufacturers highly recognize the company's capabilities and hope to strengthen their partnership.

Once again, although the short-term environment is full of challenges, the company will continue to invest in AI clouds and intelligent driving, while believing that the mobile ecology will continue to generate a lot of profits, and the distribution of these profits will tend to invest in new AI businesses. In addition, the operating loss of the AI cloud business has shown a clear narrowing trend.

Q: What is the plan for AI chips?

A: As the company uses high-end chips and chip inventory is sufficient, there will be little impact in the short term, but the shortage of low-end chips is severe. In addition, we will replace the shortage of chip types.

In the future, the company will launch its own developed AI chip. Currently, Kunlun chip is being used internally for large-scale AI computing tasks and is also applied to some external user service projects. The company has chip capabilities that can further improve end-to-end efficiency through Kunlun chips, achieving better text and image recognition. Efficiency is expected to increase by about 40%, and total costs are expected to decrease by 22.3%.

The development of China's intelligent driving market is rapidly driving many companies to further develop chips, and the trend of domestic chip replacement is emerging.

Risk disclosure and statement of this article: Dolphin Analyst Disclaimer and General Disclosure