Concerned About Overblown Ad Spending At Baidu? Don't Be

• The share price of Baidu Inc (ADR) BIDU has declined almost 23 percent over the past three months.
• Jefferies’ Cynthia Meng has upgraded Baidu from Hold to Buy, while maintaining the price target at $210.
• Meng believes that the concerns over search ad spending are overblown and that the company’s topline is likely to be minimally impacted by the spend.

“We believe the stock has largely priced in suppressed earnings growth expectations, and high level O2O spending at this stage is necessary for expansion of mobile ecosystem and payment users,” Meng stated.

Jefferies’ recent checks with top ad agents suggested that performance based ads were witnessing robust traction, while the total ad budget cut was largely offset via greater allocation for keyword search from display ads. The ad sensitivity analysis indicated that there could be downside of 12-24 bps to the FY15 revenue and profit estimates.

According to the Jefferies report, “Given current low payment transaction market share, we believe that Baidu is at the stage of having to continue spending for O2O and payment user expansion.”

Meng also believes that the current stock valuation prices in suppressed earnings growth in the near term. The consensus forecasts for FY15-17 profits have been revised down following the last earnings release by Baidu.

With the 31 percent decline in Baidu’s share price since May 2015, the current share price is undemanding, while trading at a 2 percent premium to the Internet peer average, according to Meng. Disposal of loss making businesses, such as iQiyi, could lead to potential upside.