Summit's Guo Downgrades Baidu On O2O Concerns

• Summit Research has downgraded Baidu Inc BIDU to Hold on margin weakness
• The firm believes that Baidu’s investment in O2O initiatives will negatively impact its bottom line
• Summit remains bullish on Baidu’s core search business

Summit Research has downgraded Baidu from Buy to Hold, citing weak margins due to the company’s O2O investment initiatives. In a new note, analyst Henry Guo discusses the impact that O2O spending is having on Baidu and what shareholders can expect in coming months.

Core business remains strong
Guo notes that Baidu’s core search business continues to deliver. In fact, he believes that the search business could be strong enough to drive Baidu to deliver in-line revenue throughout the rest of 2015, despite the recent weakness in the Chinese economy.

However, Guo warns that investors shouldn’t expect much upside to advertising revenue, as the typical approach in China right now from an ad budget standpoint is one of caution.

Bottom line weakness
While Guo believes that Baidu has a good chance at meeting top-line consensus estimates in Q3 and Q4, Summit’s downgrade is based on the firm’s belief that Baidu will have difficulty meeting profit expectations.

“We believe the company’s aggressive investments in O2O initiatives should significantly pressure the company’s margin for a long period of time,” Guo explains.

Summit believes that the company’s O2O investments will make it difficult for investors to identify reliable performance trends over the next several years.

The numbers
In addition to the downgrade, Summit has reduced its price target for Baidu from $205 to $150 and reduced its 2015 and 2016 non-GAAP EPS estimates by 4.5 percent and 13.9 percent, respectively. Summit is now calling for 2016 earnings of $7.48 per share, below consensus estimates of $7.72.

Disclosure: the author holds no position in the stocks mentioned.