Baidu's profit surges after curbing spending to prep for AI

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(Bloomberg) -- Baidu Inc.’s move to slash spending on services from food delivery to travel helped the search giant soundly beat estimates, as it recovers from Chinese government restrictions and prepares to invest more in artificial intelligence.

China’s largest search engine reported a better-than-projected 83 percent leap in net income after both general and traffic acquisition costs shrank. It’s also considering a change in its operating structure to allow a rapidly growing finance unit -- a source of concern to Moody’s Investors Service, among others -- operate more independently.

Baidu forecast revenue for the third quarter of 23.1 billion yuan ($3.4 billion) to 23.8 billion yuan, versus the 23 billion yuan average of analysts’ estimates compiled by Bloomberg. Net income soared to 4.4 billion yuan in the June quarter, sharply outpacing projections for 2.9 billion yuan.

The beat comes at a vital time for the company. It’s asking investors to back investments in content and artificial intelligence projects such as autonomous driving, even though expensive forays into new businesses such as food delivery have failed to deliver market leadership. Group President Qi Lu has said the search giant can beat Alphabet Inc. at driverless cars within three to five years thanks to its Apollo program, which opens the technology up to partners.

“Our focus is to accelerate the commercialization of AI technologies,” he told analysts on an earnings call.

Its U.S.-listed shares jumped 7.5 percent in extended trading. Baidu has cut back on costly subsidies and discounts for its struggling travel and food delivery units, part of an expansion into so-called online-to-offline or on-demand services.

But the company remains committed to spending big on TV and movie rights for a Netflix-like streaming video service called iQiyi, which has over 30 million paying subscribers. It also plans to buy content for a news aggregation service that relies on AI to target ads and content at 100 million daily active users.

“Marketing spending for O2O has come down quite visibly,” said Kirk Boodry, an analyst with New Street Research. “While the numbers for the quarter looked good, we think the costs for their content this year are probably going to be back-loaded.”

Revenue rose for a second straight quarter. Sales jumped 14 percent to 20.9 billion yuan in the June quarter versus projections for 20.7 billion yuan.

Online marketing revenue rose 5.6 percent, though the number of customers was down more than 20 percent. Baidu’s ad business was hit hard last year after the government imposed harsher regulations and changed the tax status of a key product. The entire customer base had to re-register with stricter conditions and many chose to switch platforms, reducing the pool of advertisers. As a result, the company reported its first annual earnings decline since its 2005 initial public offering.

Baidu is now counting on AI projects to offset slowing growth in its core business of selling internet ads placed next to search results. One example is its financial services group, which lends money to students and others using the technology to determine credit risks. The push led Fitch Ratings and Moody’s to place the company on review for a potential downgrade - both ratings agencies said the risks of such businesses were very different from its traditional strength as a search engine.

Baidu is now in the early stages of considering the structure of its finance arm. While Baidu’s Lu didn’t provide specifics, it may be trying to reduce risk while helping it get financial licenses available only to domestically controlled companies. Alibaba Group Holding Ltd. and Inc. have cited similar reasons when considering spinoffs of their own financial services businesses.

“We are beginning the process of working out a future operating structure that allows FSG to operate more independently to expand into areas that may require domestic licenses and enable stronger long term growth,” Lu said.

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