Over the last two decades, China has emerged as one of the biggest innovators in the world, threatening the technological dominance of the United States. However, the recent launch of ChatGPT has tilted the odds in favor of the U.S. once again, with American tech giants driving the artificial intelligence sector forward. With tensions rising between the U.S. and China, the East Asian economic superpower has resorted to supporting its tech sector in a bid to develop groundbreaking AI technologies. The Peoples Bank of China – the equivalent of the Federal Reserve - surprised the market on June 13 by slashing the seven-day reverse repo rate by 10 basis points to 1.90%, which is a clear indication that policymakers are willing to offer the much-needed stimulus to kickstart China’s economic growth. Amid improving macroeconomic conditions, increasing support from regulators and the projected boom in the use of AI technology, Baidu Inc. (BIDU, Financial) seems well positioned to grow.
Baidu has a headstart in China
Chinese tech giants such as Baidu and Alibaba Group Holding Ltd. (BABA, Financial) are aggressively investing in large language models to offer alternatives to ChatGPT. According to recent tests conducted by Xinhua Institute, Baidu’s Ernie chatbot ranked the highest among Chinese ChatGPT alternatives. Xinhua compared the following chatbots to determine which of the products offers the best experience to users:
- Baidu’s Ernie
- Alibaba’s Tongyi Qianwen
- iFlytek’s SparkDesk
- SenseTime’s SenseChat
Xinhua tested many general capabilities of these chatbots, including basic language skills, intelligence, subject knowledge and even the logical reasoning behind a specific answer to a question.
All the chatbots tested failed to match the performance of ChatGPT, which was launched last November. In March, Baidu CEO Robin Li said the Ernie bot is at least two months behind ChatGPT and that it could take some time to fill the gap depending on how quickly the technology evolves into a better version. With China decisively behind the U.S. in AI technology, Chinese tech giants have ample room to grow in the next few years if they can fill this technology gap. Baidu’s Ernie bot has already scored a win by emerging as the best ChatGPT alternative according to Xinhua, and the company can build on this headstart to rival the likes of Alibaba in a fast-growing niche.
Innovation is at the heart of business strategy
Baidu has focused on AI-related investments for nearly a decade, though these investments are only now beginning to deliver results. For instance, Apollo, Baidu’s autonomous driving business unit, is emerging as the leader of self-driving vehicle technology in China. The company has been investing in this business unit since 2014. Going by global trends, it is reasonable to expect automakers to partner with tech companies to deploy self-driving technology in their vehicles rather than investing billions of dollars to build such technology in-house. Baidu’s Apollo, therefore, stands to benefit from the rising popularity and use cases of autonomous driving.
The company also has an unwavering focus on making the most of AI technology. As part of its plan to become the AI leader in China, Baidu launched a $145 million venture capital fund last month to invest in startups that are focused on utilizing AI to generate content. The company also announced it will launch a competition for developers to build applications using its Ernie bot.
The company is returning to growth
After more than a decade of continued top-line growth, Baidu’s revenue declined 8.5% in 2022, making it the worst year for the company in recent history from a financial performance perspective. With the reopening of the Chinese economy in December, Baidu has made a strong comeback, which is evident from its first-quarter financial performance.
The advertising business, which forms the company's backbone, returned to growth in the first quarter, alleviating some of the concerns raised by investors. The cloud business became profitable for the first time in eight years as well, which highlights the strong momentum behind this business segment. Aided by macroeconomic trends such as remote working, remote learning and digitalization, Baidu’s cloud business seems well-positioned to grow in the next five years.
Short-term challenges
Although the reopening of China will benefit Baidu, its massive reliance on the advertising business (more than 70% of revenue) may come to haunt it if economic growth hits a roadblock in the coming quarters due to macroeconomic and geopolitical pressures. The advertising business is highly sensitive to the business cycle effect, and an economic downturn is likely to lead to a substantial decline in advertising revenue. This risk is likely to hover over the company for the foreseeable future as there is no clarity regarding the outlook for the global economy in the second half of the year.
The company will also have to deal with pressures on operating margins resulting from its aggressive investments in AI technology. As the leading search engine operator in China, Baidu can immensely benefit from an integration of its search engine capabilities with AI technology, and the company has identified this opportunity. However, to make this a reality, Baidu will have to take a hit on short-term operating margins, which might trigger a negative response from investors.
Takeaway
At a forward price-earnings ratio of 19, Baidu is cheaply valued considering the long runway for growth it enjoys. The company has emerged as a leader in AI technology in China, and investors are likely to reward it handsomely in appreciation of its efforts in a crowded market.
Although short-term risks persist, Baidu’s long-term outlook remains bright.
