Baidu's Mobile Search Leadership Sustains Ratings

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Fitch Ratings says that Baidu's continued solid performance in 2Q14 reinforces its belief that Baidu's cross channel leadership in search advertising in China will continue to sustain its credit profile, which will also be supported by its continued investments in the mobile platform and new technologies.

Fitch expects there will continue to be strong growth in Baidu's mobile revenues in the next two to three years due to the company's leading positions in mobile search, mobile map and app distribution, which are the three key entry points to the internet.

Its search app, Mobile Baidu, had 70m daily active users and its mobile map app had 200m monthly active users in 2Q14. In addition, the combined Baidu and 91 Wireless platform distributes over 130m app downloads daily.

Fitch believes that Baidu will continue to benefit from increasing budgets for advertising on the mobile platform. In 2Q14, mobile search traffic again was the major driver of Baidu's overall traffic growth. In terms of monetisation, Baidu reported that the number of paid clicks, cost-per-click and click-through rates are improving, largely due to the company's investments in mobile and technologies such as deep learning. As a result, Baidu's revenue grew at 59% yoy in 2Q14 and mobile revenue reached 30% of its 2Q14 revenue.

Baidu's margins are likely to recover in the next two years after the transition to develop its mobile platform. Baidu is committed to further strengthen its market position and will continue to invest in its mobile services. This may constrain margin improvements in the short term. However, margins should recover when mobile monetisation further improves and spending stabilises. In 2Q14, Baidu's EBIT margin rebounded to 30% from 25% in 1Q14, due to a slowdown in pre-installation spending and content costs.

Fitch expects Baidu to maintain strong financial flexibility and ample liquidity over the medium term. The company generated strong cash flow in 2Q14 with net operating cash flow increasing to CNY4.1bn from CNY3.6bn in 1Q14. Including short-term investments, where the company parks its surplus cash, Baidu had unrestricted cash of CNY12.4bn and near cash of CNY36.3bn at end-June 2014, which together were equivalent to 200% of its total debt.

Baidu currently is well above the floor of its ratings' limits. However, Fitch may downgrade the ratings if there is evidence of greater government, regulatory or legal intervention leading to an adverse change in the company's operations, profitability or market share; Baidu's operating EBIT margin drops to below 10% (35.0% in 2013); pre-dividend free cash flow/sales ratio falls below 10% (31.7% in 2013); or funds flow from operations-adjusted leverage rises above 2x (1.7x for 2013), all on a sustained basis.

For the short to medium term, Baidu profile is at its ratings' ceiling and takes into account Fitch's expectation of profit growth. Fitch may consider an upgrade if the company develops businesses that materially diversify cash generation away from operations that are subject to Chinese government and regulatory risk, provided such diversification does not damage the company's financial profile.

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Tags: baidu  fitch ratings  China 

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