Why Merrill Lynch Is Much More Positive on Baidu Now

Baidu Inc. (NASDAQ: BIDU) recently has enhanced its leadership through the successful transition to mobile. Additionally this company is improving display technology to support more data format and contextual advertising on its website partners. Also, as the result of a recent business update, Baidu caught the attention of one key analyst.

Merrill Lynch has a Buy rating on Baidu and raised its price objective to $232 from the previous level of $213.

In the update, Baidu released more information about its advertiser base, paid search queries and video business (iQiyi) in its 2015 20F filing. As this information is not disclosed on a quarterly basis, Merrill Lynch only uses it as a sanity check on its 24% search sales growth forecast for 2016, which seems to be reasonable.

Annual advertisers grew by 29%, to over a million, after a slow 2014, bringing the 2013-15 compound annual growth rate (CAGR) to 18%, which is largely on track with annual growth rates between 18% and 26% in 2011 to 2013. Average advertiser spending was up by about 2% year over year, mainly due to the addition of small advertisers.
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As the deconsolidation of Qunar in the fourth quarter reduced the advertiser base by 10%, the annual advertiser growth could slow to single digits in 2016. On the other hand, newly added advertisers should increase spending in 2016, after getting familiar with the platform. Hence, a double-digit rise in spending could offset slow advertiser growth. Note that advertiser spending grew at a 33% CAGR over the past decade.

On the traffic side, paid search queries increased by 34% in 2015, mainly driven by mobile traffic, which grew from an estimated 50% or so of total traffic in the fourth quarter of 2014 to an estimated 66% in the fourth quarter of 2015. As 3G/4G subscribers still grew at a healthy 25% in January and February, mobile should remain a driver in 2016. PC traffic, which could decline, is a risk factor. Price per paid query dropped by 5% in 2015, due to the dilution from lower-priced mobile ads, but Merrill Lynch believes that the pricing trends of mobile and PC, when measured separately, were stable or up. Baidu’s technologies to improve ad relevance and, hence, pricing per paid query should become more important.

In its report, Merrill Lynch detailed:

We estimate first quarter total ad sales of RMB15.1b (21% YoY) and other sales of RMB0.9b, driven by a 30%+ increase in video subscribers. We model GAAP net/EPADS of RMB1.1b /US$0.5 in 1Q16 on stable expenses, negative seasonality in ad and a higher tax rate. We also introduce our 2018E, with 18% growth in sales and op profit. We note that, in the 20F, iQiyi’s non-content expenses were significant, at ~9% of Baidu’s total expenses.

Shares of Baidu were trading up more than 3% at $193.32, with a consensus analyst price target of $214.02 and a 52-week trading range of $100.00 to $223.95.