Searching for directions

Baidu reinvention needs a roadmap to profit

Baidu's reinvention needs a roadmap to profit. The Chinese search engine giant has begun to explain its big bets on "online-to-offline" services. There's promise, but competition is fierce and subsidies are rife. Investors have knocked 19 per cent, or $15 billion, off Baidu's market capitalisation this year. They need a clearer idea of where it is headed in O2O.

The online giant proclaims it is building the "Next Baidu". Yet second-quarter numbers, released on July 27, unsettled investors. The first worry is how heavily dependent it remains on search.

Search-related advertising made up 98 per cent of revenue in the quarter. Year-on-year sales growth of 37 per cent was more than triple the rate at Google. But for China's most popular search engine operator, the rise of mobile devices has squeezed profitability: half of revenue now comes from mobile, but advertisers pay less for smartphone users than those sitting at PCs.

The second, larger concern is about Baidu's aggressive push into mobile maps and O2O services. It has committed 20 billion yuan ($3.2 billion) over three years to its group-buying site that offers deals on restaurants and tickets. Promoting and subsiding O2O campaigns pushed up sales, general and administrative expenses up 81 per cent to 3.9 billion yuan.

Baidu cannot afford to miss this shift to the next phase of China's mobile web. And the promotional blitz is attracting customers: transactions in Baidu's main O2O sectors of travel, food and group-buying more than doubled to 40.5 billion yuan, the company disclosed for the first time.

But for now commissions are low. O2O forays halved Baidu's operating profit margins to 21 per cent. And management expects O2O spending to increase further in the second half, as online rivals including e-commerce group Alibaba and gaming giant Tencent enter the battle for takeaways and group-buying. Venture capital-backed groups are also pouring huge sums into the sector.

After falling after-market, Baidu shares now trade on just under 23 times forward earnings, versus a five-year average of 28.5 times. The group needs to reassure shareholders by explaining what sort of sales and margins a mature O2O business can generate, and when.