Baidu’s Results May Shake Optimism Over China AI: Tech Watch

2023-08-21 10:16

Investors betting on an extension of Baidu Inc.’s market-beating rally may be due for a reality check as

Baidu’s Results May Shake Optimism Over China AI: Tech Watch

Investors betting on an extension of Baidu Inc.’s market-beating rally may be due for a reality check as concerns about the sluggish Chinese economy and setbacks from a key segment of its business deepen.

Citigroup Inc., China International Capital Corp. and Daiwa Capital Markets Hong Kong Ltd. are among brokers that have lowered their earnings expectations in recent weeks ahead of the search engine provider’s second-quarter results due Tuesday, with analysts expecting a slowdown in adjusted net income growth.

Baidu has been deemed as one of the most promising Chinese technology players thanks to its early move in developing the nation’s first homegrown ChatGPT-like service. The company’s shares have gained about 13% this year through Friday, ranking among the best performers on the Hang Seng Tech Index, which has lost 3%.

Yet, disappointments related to its Ernie Bot along with lackluster consumption remain key hurdles. Without a stronger demand pull or updates to its AI project, the outlook for its shares is cloudy at best. Options traders are already on board. Baidu’s put-to-call ratio based on option interest, an indicator of relative bearishness over a stock, has increased this month. The volatility skew, which reflects market sentiment and positioning, is also showing rising pessimism.

“Expectations have been lowered for the second quarter and beyond for Baidu,” said Kai Wang, an analyst at Morningstar Inc., who sees soft demand for the advertising industry. The company faces macro headwinds and is likely to see weaker operating margins due to the build-out of the AI products, he added.

One concern among analysts is Baidu’s AI cloud revenue growth, which is forecast to slow in the third quarter due to delays in smart-transportation projects in China. The sluggish economy has forced local governments to run tighter-than-normal budgets in a bid to weather the storm, which in turn is feeding the delays. That has led Citi to trim its price target and turn more cautious on the company last month.

“Given the relatively higher base from last year, together with a recent downward revision of GDP forecast by Citi economists, we conservatively tweak down” revenue forecast for AI and advertising for the third quarter, analysts including Alicia Yap wrote in a note.

There are still reasons to remain optimistic. Baidu continues to be the best-positioned Chinese internet firm given its early pivot to AI opportunities even if they aren’t profitable just yet, according to Goldman Sachs Group Inc.

Still, with competition rising and the economy slowing, the outlook is dim. Tencent Holdings Ltd. said last week that it is developing one of China’s best AI models while Alibaba Group Holding Ltd. is integrating a ChatGPT-like AI into its meeting and messaging apps. Baidu’s share rally has trounced the meager gains in peers Alibaba and Tencent this year, but has been losing steam recently.

“Baidu is viewed as being in the lead for generative AI because of its more visible investments over the years,” said Vey-Sern Ling, managing director at Union Bancaire Privee. “But the development of generative AI applications is still at an early stage,” he said, adding that investors shouldn’t rule out Alibaba and Tencent launching products in this area.