NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo

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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
Baidu, Inc.
   NASDAQ: BIDU
Recommendation: SELL
 Angela Wang and Lily Luo

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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
Investment Thesis
Recommendation:
Baidu, Inc. (NASDAQ: BIDU) has substantial long-term downsides in the market, therefore we
recommend a sell.

Rationale:
Baidu is unlikely to return to strong organic growth due to headwinds in the company's digital
advertising business, a failure to effectively create content in its new in-app services, and
inefficient investment in AI.

             1    Advertising business slowdown

             2    Uncompetitive and low-quality content on Baidu platforms

             3    Inefficient investment in AI

                                        Price Target: $103.46
                            11.9% downside to current price of $117.44

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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
Company Overview
                      Company Profile                                                      Historical Stock Chart
                                                                                                                                           Volume
§   Baidu, Inc. is a Chinese internet search company that engages
                                                                    $310.00                                                               60,000,000
    in the provision of internet search solutions and online        $290.00
    marketing solutions                                             $270.00                                                               50,000,000
§   Baidu offers an array of products such as Baidu Feed, Quanmin   $250.00
                                                                    $230.00
    Karaoke App, Baidu Knows, and Baidu Encyclopedia                $210.00
                                                                                                                                          40,000,000

    •    It generates the majority of its revenue from online       $190.00
                                                                                                                                          30,000,000
         marketing and advertising services                         $170.00
                                                                    $150.00
§   Besides the Baidu Core segment, it also operates through        $130.00                                                               20,000,000
    Baidu maintains 56.6% ownership of iQiyi shares (March 2019)    $110.00                                                               $117.44
                                                                     $90.00                                                               10,000,000
    •    iQiyi, Baidu’s video-streaming subsidiary, which is an
                                                                     $70.00
         online membership video platform                            $50.00                                                               0
§   The Company also invests in technology including artificial

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    intelligence and autonomous driving

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               2019 Revenue by Segment                                           Revenue Breakdown ($ in millions)
                                                                    $18,000                                                                   40%
            Other                                                   $16,000
                                                                                                          13   .65%                           35%
                                                                                                    CAGR:
                                         Online Marketing
            27%
                                         Services:                  $14,000                                                                   30%
                                                                                                                       $2,724    $3,971
                                         advertisements on          $12,000
                                                                                                             $1,462                           25%
                                         Baidu search and iQiyi
                                                                    $10,000             $343        $848
                                                                                                                                              20%
           Online Marketing                                          $8,000     $81
               Services                  Other: revenue                                                                                       15%
                                                                     $6,000                                            $11,969   $11,474
                 73%                     generated from Baidu                                                $10,688
                                                                                         $9,357     $9,428                                    10%
                                                                     $4,000
                                         Core and iQiyi                        $7,086
                                                                     $2,000                                                                   5%
                                                                        $-                                                                    0%
                                                                               2014       2015       2016    2017      2018     2019
                                                                              Online Marketing Services      Other         EBITDA Margin

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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
Industry Overview
                                Overview                                              Search Engine Market Share
 §        Baidu remains the leading search engine in China
                                                                                           4% 3%
 §        Google exited China in 2010, and unlikely to come back to                                                      Baidu
          China due to censorship and security rules                                  7%
                                                                                                                         Shenma
 §        Newly emerged search engines penetrate market quickly
                                                                                                                         Haoso
          •    Shenma: only available on mobile                                15%
          •    Toutiao: launched by ByteDance, leverage content from                                                     Sogou
                                                                                                     71%
               popular TikTok video app                                                                                  Others
 §        Shopping searches: support online shopping and e-commerce
          by searching for product information
 §        News searches: trending information and breaking news

              Revenue Outlook of Search Engines in China                                           Key Drivers
$ billion
                                                                                       • 98% of Chinese internet users are mobile users
   35.
                                                              29.1     Mobile users    • Mobile devices is the main source of raw
  30.                                       %
                                    R: 14.2           25.3                               searches
  25.                           CAG           22
                                     18.8                                              • Marketing is the main revenue source of search
  20.
                             16.1                                      Advertising       engines
  15.          11.5   12.4                                                             • Slowdown advertising business due to the trade
  10.                                                                                    war

     5.                                                                                    • Quality control: select high quality content
                                                                         Artificial
     0.                                                                Intelligence        • Improve user relationship management
               2015   2016   2017    2018    2019*   2020*    2021*

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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
1       Advertising business slowdown
           Declining Search Engine Advertising Market                                    Increase of Advertisement Inventory
           Market Shares of Online Advertisements by Format in China (%)       §   Alibaba e-commerce advertising
                            13.5        12.2       11.3                            •    Ideal platform for businesses to advertise and sell
    20.2         14.5
                                                    9.5                                 products through Taobao and T-Mall
                 12.6       11.4        10.4               Other
    13.7                                                                       §   Tencent’s Ad Network
                 18.4       23.9        30
                                                           Brand Display ads       •    Wechat, QQ, Tencent News, and Tencent Video provide
    12.5                                           35.1
                                                                                        1bn user base
                                                           News Feed ads
                                                                                   •    Tencent Alliance Ecosystem: 75% of top apps (100,000)
    28.2         31.8                                                                   with 500mm users, give budget string as low as $150
                            31.7        30.3               E-Commerce Ads
                                                   29.2
                                                                               §   iQiyi: advertising business slowdown
                                                           Search ads
    25.4         22.7                                                              •    Removed false advertisements due to government
                            19.5        17.1       14.9                                 regulations
    2016         2017       2018       2019       2020                             •    Lower than expected demand for tech-advanced in-feed
                                                                                        advertising platform
    2       Uncompetitive and low-quality content on Baidu platforms
                          Unfavorable Content                                                   Shrinking Dominant Power
§       Baijiahao: platform for independent writers, bloggers, and
        journalists to write articles and opinion                              Popular Baidu
           §    No selections and no constraints                                   Apps
                                                                                Before 2012         Baidu       Baidu        Baidu       Baidu
           §    False information and low-quality contents
                                                                                                    Map         Music        Knows      Post Bar
           §    Baidu search promotes Baijiahao excessively

§       Mini-programs: apps within Baidu app
                                                                               Public Favored
            §    Wechat launched mini-programs earlier in 2017                 Replacements
            §    Wechat has over 1 billion monthly active users in 2019           In 2019
                                                                                                  Google Map      QQ Music
            §    Baidu has 315 million monthly active users in 2019                                                                  Zhihu
                                                                                                    Alibaba        Tencent

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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
3         Inefficient investment in AI
                            AI Long-term Investment                            AI Implementation in Baidu’s Core Business
§       Baidu’s AI investment is still at an early stage
                                                                                            §   Multi-mode interaction
§       Huge amount of expense goes into the research and
        development of autonomous driving, which is not a part of the      Baidu DuerOS     §   Pilot driving monitoring
        core business at all                                               smart devices    §   Onboard Cyber Security
§       Integration of AI into search engine improves user relationship                     §   Vehicle Intelligent Program
        management
§       The return of the investment can only be seen in the long run
                                                                                            §   Optimize visual speech processing
                                                                                            §   Help customers increase productivity
                                                                           Baidu Cloud      §   Improve operational efficiency
                                                                                            §   AI-powered video editing solution
                                                                                            §   AI call center enterprise solution

                                                           AI Investment in Apollo
§       In September, Baidu launched Apollo powered robotaxi pilot
        program, which leverages Baidu’s V2X solution that improves
        sensors and traffic efficiency
§       Unlike Google and its autonomous driving subsidiary Waymo,
        Baidu did not take part in designing the hardware and collecting
        the data during the experimental stage, causing safety problems
        during the test
§       Disclaimer of Apollo: the platform of Apollo and Baidu are not
        responsible for any false information, sensor problems, and
        safety issues
§       Other big motor companies will soon become Baidu’s
        competitors, and autonomous driving currently does not apply to
        people’s need

1Difference   in revenue is due to rounding.
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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
Possible Upside
       Ecosystem of Third-party Content and Service                                               Future Entertainment Spending
                                                                          $ billion
                                                                            350
            Feed
           Content                                                          300
           Network                                                          250

                                                       All-in-one           200
                                                      App: search,          150
                                                      watch, read
                                                                            100

            Smart                                                              50
             Mini                                                              0
           Program                                                                        2015         2016          2017       2018     2019    2020

                                                                                             Games         Mov ies          Anime      Music    Books

                iQiyi’s Investment in Original Contents                                                  Healthcare Initiatives
                   Number of Paid Subscribers of iQiyi (million)           §          Artificial Intelligence in healthcare sector
   120                                                                                   §       Donate AI fundus screening integrated machines,
                                                                   106
                                                                                                 covering 56 million people at risk of eye disease
   100
                                                      80.7                               §       Takes 10 seconds to create a screening report for the
     80                                                                                          user
                                                                                         §       Reshape healthcare industry with AI
     60                                        50.8

     40                              30.2
                                                                           §          Baidu Doctor in 2015: online medical service provider
                                                                                         §   Allows users to contact local doctors, make
     20            10.7                                                                      appointments, and ask questions
       0                                                                                 §   Conversational bot named Melody that can perform
                   2015             2016       2017   2018         2019                      basic triage on patients in late 2016

1Difference   in revenue is due to rounding.
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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
Investment Analysis
           Why We Bought Baidu?                                What Has Changed?

 Dominate search engine in China with strong        Losing its dominant position due to intense
              barriers to entry                     domestic competition and declining search
                                                            engine advertising business

                                                    iQiyi revenue growth offset by losses due to
                                                       declining advertising business and high
 Growth in video streaming on iQiyi platform
                                                    investment in original content and premium
                                                                      content

Strong core business enhanced by investment        Apollo has safety and function issues and does
                    in AI                            not meet the need of the current market

Opportunity for initiating portfolio exposure to    Tencent and Alibaba are better investment
              Chinese economy                                        choices

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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
Key Risks
                     Key Risks                                            Mitigants

û Premium content and original content would         ü The numbers of subscriber only increased by
  attract more subscribers in the long run             3.8% from 96.9 million to 100.5 million from Q1
                                                       to Q2 in 2019
û The implementation of AI improves users’
  experience and Baidu’s user relationship           ü Intense competition in the industry and the lack
  management                                           of marketing make it difficult to build loyal
                                                       customer base
û Creating an ecosystem of third-party content and
  services through Baijiahao and smart mini          ü Low-quality content makes people choose to use
  programs                                             other alternatives for high-quality information

û The number of daily active users of Baidu app      ü Gradual process of user growth turning into
  and smart mini programs is increasing                revenue growth

û China’s first search engine company adopts in-     ü Requires large investments in marketing for app
  app service model                                    installation and user education

û Healthcare medical initiatives pave the way for    ü Baidu was historically criticized for displaying
  its deployment in the AI healthcare sector and       false medical advertisements and eliminated its
  increase brand awareness                             medical sector in 2017

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NASDAQ: BIDU Baidu, Inc. Recommendation: SELL - Angela Wang and Lily Luo
Final Recommendation

                                     Base Case                Upside Case

                                 Price Target: $103.46     Price Target: $159.6
                                   Downside: 11.9%            Upside: 35.9%

Recommendation:
Baidu, Inc. (NASDAQ: BIDU) has substantial long-term downsides in the market,
therefore we recommend a sell.

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Appendix

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Valuation – Comparable Companies Analysis

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Valuation – WACC

                   WACC Calculation
                                        Capital Structure
                   Debt-to-Total Capitalization             20.7%
                   Equity-to-Total Capitalization           79.3%

                                          Cost of Debt
                   Cost of Debt                              3.6%
                   Tax Rate                                 20.0%
                   After-tax Cost of Debt                   2.88%

                                         Cost of Equity
                                  (1)
                   Risk-free Rate                            3.0%
                                           (2)
                   Market Risk Premium                       6.7%
                   Levered Beta                                1.3

                   Cost of Equity                           11.45%

                   WACC                                     9.68%

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Valuation – DCF (Base)

                         14
Valuation – DCF (Base)

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Valuation – DCF (Upside)

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Valuation – DCF (Upside)

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