We picked this story up on Seeking Alpha.  It offers an interesting insight by an independent analyst:  Vishesh Raisinghani

  • AI is all about the data, and China has reserved its regional data for local players.
  • Baidu is the country’s biggest search and mapping company, which puts it in a favorable position for self-driving and digital marketing AI development.
  • Baidu’s core business (minus the AI investments) is relatively undervalued which provides downside protection for risk-averse investors.

“That’s how knowledge works. It builds up, like compound interest,” Warren Buffett once told an audience. Of course, Buffett was talking about the value of reading, but his thesis about compounding knowledge works not just for human but also for machines.

When people talk about artificial intelligence today, what they usually mean is machine learning. Researchers come up with a new model (algorithm), feed it data to help it learn, and then test it in the real world. According to industry pioneer Andrew Ng, the data here is more important than the algorithm itself. That’s because vast computational power is mostly a commodity now and a handful of clever engineers can come up with a relatively robust algorithm, however, the ultimate prize in the AI research world is a giant pool of high-quality data. Following the data will lead to the winners in this space.

Baidu (BIDU) appears to be a company with a stranglehold on a rarefied pool of data, which makes it one of the most interesting artificial intelligence stocks on the market today. Here’s a closer look at Baidu’s critical advantage in the next industrial revolution and its implications for investors.

China’s data lagoon

You’ve got to admire the Chinese government’s foresight. Unlike any other country in the world, China has managed to barricade its local data and allowed only a handful of local tech companies to blossom on top of it. Google (NASDAQ:GOOG) (NASDAQ:GOOGL), Facebook (NASDAQ:FB), and Twitter (NYSE:TWTR) are completely blocked off from the country. If you want to test the resilience of the Chinese Firewall, try downloading a Google map of Shanghai for offline use before travelling there. It won’t work.

For the Communist Party, a backdoor to the data helps them crackdown on dissent and closely monitor the population. In recent years, the CCP has used this power to monitor studentsanalyze people’s emotions, figure out their sexual orientation, and assign credit scores to everyone.

However, for the tech giants, this walled garden is a paradise of opportunity. Baidu has been one of the primary beneficiaries, having built a search engine that has over 76% dominance in China’s search market and over 82% in mobile search. Meanwhile, Baidu Maps is the clear winner in China’s mapping market, with 70% share. The company is also rolling out maps to the Southeast Asian countries Chinese tourists are most likely to visit – Japan, Thailand, South Korea, and Singapore.

So, Baidu has access to over 700 million internet users and nearly 4.7 million kilometers of road data that Google doesn’t. Not to mention the fact that Baidu has had this access for over a decade, which gives the company an edge even if China lifts the ban and gives Google full access (unlikely).

Baidu’s hold on China’s most vital data (search and mapping) seems to be well cemented, but what else does the company have going for it?

AI Talent

Remember Andrew Ng, the industry pioneer I mentioned at the start of this article? Well, Ng initially worked at Google but left Silicon Valley to help Baidu build its AI team in 2014. Over the three years he was there, he expanded Baidu’s AI research team to thousands of people.

The global pool of AI talent is severely limited. Reports suggest that internet giants like Google and Baidu are offering salaries of more than $1m to attract talent with reasonable experience. Recently, it managed to poach 3 senior AI researchers from Microsoft (NASDAQ:MSFT) and IBM. With nearly $20b in cash on the books and plans to invest the bulk of cash flows into emerging AI technologies, BIDU can sustain this high-stakes war for talent.

What Does This Mean For Investors?

With its dominance of regional data, support of the Chinese government, healthy balance sheet, and ability to attract world-class talent, Baidu is in a particularly favourable position to dominate at least China’s AI market (Google may be more likely to dominate global AI).

Right now, the company is focused on creating a conversational AI system (DuerOS), a self-driving car platform (Apollo), and an AI solution for enterprise (EasyDL). These are just the AI projects and investments we know about. It’s hard to imagine the company doesn’t have AI projects ranging from healthcare to digital marketing in the works. But I digress.

Source: Engadget

By my estimate, Baidu doesn’t need to dominate all sectors of AI across the world to make a noticeable impact for investors. Take the self-driving Apollo project for example. We already know that Baidu Maps is the most popular mapping solution in China. We also know that Baidu has over 100 self-driving buses that operate at Level-4 autonomy in private driveways. The company’s partnerships include Daimler (OTCPK:DMLRY), Nvidia (NASDAQ:NVDA), Bosch (OTC:BSWQY), Ford (NYSE:F), and Velodyne. So, it’s a serious contender in the self-driving space.

According to estimates from McKinsey, China’s self-driving market could be worth $500b by the year 2030. Nearly half of that is the sales of automobiles, but the other half is autonomy services. Which means the potential market opportunity for Baidu is nearly $250b. Even if it can get just a third of that market (assuming serious contenders like Tencent (OTCPK:TCEHY) and Alibaba (OTCPK:BBAAY) get the rest), the potential is $83b. For context, Baidu’s market cap today is just over $61b.

In other words, even moderate success in self-driving in China alone is worth more than the company itself. (I’ll explore the lucrative opportunity of self-driving in China in more detail in a follow-up article later this week. Subscribe to my SA profile to get updated).

Does the valuation justify it?

Like a lot of other listed tech companies that have been around for more than a decade, Baidu is in a seriously good financial position. Its stock trades at 21 times net income, nearly 14 times operating cash flow, and the return on assets recently reached 9.88%.

In fact, Baidu is the perfect candidate for a game I like to call ‘Valuations Based On Overly Pessimistic And Highly Unlikely Assumptions’. Here are the assumptions:

  • All the money Baidu invests in AI is wasted and the company is still just a search and mapping company by 2028.
  • At least two-thirds of operating cash flow is invested in Capex and AI (among other things).
  • The digital search and advertising market in China only grows at the rate of GDP growth.
  • The required rate of return on Baidu stock is double the risk-free rate in China (10-year bond yield).
  • Applying a boring, old-school discounted cash flow on Baidu’s core business, we get:
Free cash flow to equity (1/3rd of Op Cash Flow 2017) x 1-year growth rate/ (Required rate – growth rate)
$1.67b x 6% / (7.4% – 6%)
$122.43b

Currently, Baidu’s market cap means even by these pessimistic assumptions, the core business is undervalued by nearly 37%. That’s a wide margin of safety for any investor.

Final Thoughts

Baidu has clearly stated its intention to focus exclusively on AI. Applying its unique pool of Chinese data and leveraging the influence of the Chinese government, the company has already made some progress. In my opinion, BIDU is one of the most attractive opportunities for investors who understand the potential of AI technology.

However, even if you strip away the investments in AI and focus exclusively on the core business, BIDU is still an undervalued buy.

The author wrote this article himself, and it expresses his own opinions.

(Note: pictures were removed, just in case they are referred to in the article)

Source: Seeking Alpha  –  For Members Only