Fitch Affirms Baidu at 'A'; Removes Rating Watch Negative.
The affirmation reflects Baidu's continued strong cash generation from its core search services and its commitment to manage exposure to its riskier Financial Services Group (FSG), including assessing structures that would allow the FSG to grow independently.
KEY RATING DRIVERS
Dominant Market Position: Baidu remains the platform of choice for advertisers to promote their products on search engines in China, despite the implementation of new online advertising regulations and the company's higher, self-imposed standards on customer verification. Baidu held a search engine revenue market share of about 80% in 2Q17, according to research firm Analysys International. It had about 83% market share in terms of search page views in October 2017, according to internet analytics firm StatCounter. Technological innovation plus high levels of brand recognition and consumer satisfaction have enabled Baidu to consistently defend its high market share.
Managing FSG Exposure: The ratings reflect Baidu's commitment and actions to manage the company's exposure to its riskier FSG business. The company is committed to restrict FSG assets/total assets to around the current level (3Q17: 16%), which should contain the business and financial risks related to the FSG. The FSG currently operates a principal model in originating loans to consumers and proprietary wealth management products for retail investors.
We believe Baidu's strong cash generation and large net cash position give it sufficient capacity to absorb potential losses in the FSG operations. If the FSG underperforms, we think that the additional funding required would not be a big enough drain on cash generated by Baidu's core operations to threaten the 'A' rating. At end-September 2017, Baidu's net cash position was about CNY30 billion. In addition, Baidu has said it will contemplate an appropriate structure that allows the FSG to operate independently, including a substantial reduction in its exposure as principal and its gradual transformation into a pure agent model over time.
Improved Profitability: The ratings benefit from the strong profitability of Baidu's core search services, although investments in artificial intelligence (AI) continue to increase and its online video business, iQiyi, is still unprofitable, reducing consolidated non-GAAP operating margin by 11pp to 24% in 3Q17. However, non-GAAP operating profit rose to over CNY5 billion in both 2Q17 and 3Q17, higher than pre-2014 levels. We expect Baidu to redeploy some savings from the Baidu Food Delivery divestment to fund AI initiatives. Improving monetisation of news feed products and iQiyi, and firmer cost-per-clicks on search services should help Baidu sustain a steady operating margin.
Strong Cash Generation: We expect Baidu to continue to generate strong free cash flow (FCF) from its core search services, which should be large enough to fund the growth of its online video services through iQiyi, its AI initiatives, and the expansion of FSG. Its cash flow from operations (CFO) increased to CNY21 billion in 9M17, from CNY14 billion in 9M16 and we expect CFO from its search services to remain strong and help stabilise the company's overall FCF margin at 17%-21% over the longer term. Baidu's FCF margin has remained relatively high, although it dropped to 17% in 2016, from 20%-45% in 2012-2014.
Regulatory Risks Well Managed: The ratings reflect Fitch's expectation of Baidu's continued healthy relationships with China's government and regulatory authorities. Should this position change, it could affect credit strength - particularly considering the rated entity's absence of equity control over its onshore operating companies. These would be Baidu Netcom, Beijing Perusal, BaiduPay and other consolidated affiliated Chinese entities with whom it only has contractual relationships, due to government restrictions on foreign ownership in internet businesses.
In 2016, Baidu generated over 60% of revenues from, and kept 89% of cash and 85% of assets within its wholly owned subsidiaries rather than at these contractually controlled, consolidated affiliated entities.
Baidu's credit profile compares favourably with that of its internet peers, such as eBay Inc. (BBB/Stable) and Expedia, Inc. (BBB-/Stable), but is weaker than that of Alibaba Group Holding Limited (A+/Stable) and Tencent Holdings Limited (A+/Stable). Baidu's cash-generation ability is weaker than that of Alibaba and Tencent. Baidu's ratings benefit from its dominance in China's search engine market, but higher investments in iQiyi and artificial intelligence will continue to weigh on its profitability.
Fitch's key assumptions within our rating case for the issuer include:
- Revenue compound annual growth rate of about 18% in 2016-2019
- Operating EBIT margin of 22%-25% in 2017-2019
- Annual capex of CNY16 billion-19 billion in 2017-2019
- Large net cash position to be sustained in 2017-2019
Developments That May, Individually or Collectively, Lead to Positive Rating Action
The ratings take into account Fitch's expectation of profit growth, and a positive rating action is unlikely in the medium term.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Higher-than-expected risks in the Financial Services Group
- Evidence of greater government, regulatory or legal intervention leading to an adverse change in the company's operations, profitability or market share
- Material loss of market share in key products and services
- Significant M&A that negatively affect the operations or the business profile
- Sustained decline in operating cash flow
- Operating EBIT margin sustained below 10%
- A shift to more aggressive financial policies, for example a sustained loss of its net cash position or sustained FFO-adjusted leverage above 2.0x. However, FFO-adjusted leverage rising above this target alone will not lead to a downgrade should the company retain its strong net cash position and high FCF margins
Strong Liquidity: We expect Baidu to continue to maintain a large net cash balance. At end-September 2017, Baidu had readily available cash of CNY100 billion. This compared with total debt of CNY70 billion, which also included redeemable non-controlling interests at subsidiaries and other financing for the FSG. Most of the debt was unsecured and denominated in US dollars. US dollar unsecured notes totalled USD6.25 billion and US dollar unsecured bank loans were USD1.15 billion. There were also USD1.23 billion of convertible notes from iQiyi.
FULL LIST OF RATING ACTIONS
-- Long-Term Foreign Currency IDR affirmed at 'A'; Outlook Stable
-- Long-Term Local Currency IDR affirmed at 'A'; Outlook Stable
-- Foreign-currency senior unsecured class rating affirmed at 'A'
-- Rating on USD1 billion 3.250% senior unsecured notes due August 2018 affirmed at 'A'
-- Rating on USD1 billion 2.750% senior unsecured notes due June 2019 affirmed at 'A'
-- Rating on USD750 million 3.000% senior unsecured notes due June 2020 affirmed at 'A'
-- Rating on USD750 million 3.500% senior unsecured notes due November 2022 affirmed at 'A'
-- Rating on USD900 million 2.875% senior unsecured notes due July 2022 affirmed at 'A'
-- Rating on USD500 million 4.125% senior unsecured notes due June 2025 affirmed at 'A'
-- Rating on USD600 million 3.625% senior unsecured notes due July 2027 affirmed at 'A'
|Printer friendly Cite/link Email Feedback|
|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Date:||Feb 6, 2018|
|Previous Article:||Fitch Rates Nanjing Yangzi's USD Notes Final 'A-'.|
|Next Article:||Fitch: China's Outbound M&A Set for Long-Run Growth Despite Dip.|