Don’t Bet on Baidu’s Chatbot Just Yet

Morningstar analysts are skeptical and have yet to reflect this new venture in their valuation model.

Morningstar Analysts are Skeptical About Baidu’s New Chatbot

Kai Wang, senior equity analyst, lists a range of fundamental issues around this bot development, which could to a certain extent destruct Baidu’s prevailing long-term initiatives.

First, the costly project will likely dilute the company’s profit margin and that defies Baidu’s longer-term direction and his investment thesis of margin expansion. Uncertainties in the aspects like monetization and effectiveness also overshadowed the potential of Baidu’s product.

Wang says: “We are optimistic that Ernie can be a long-term catalyst for Baidu, but are uncertain over its long-term cost and monetization plans.” According to him, Baidu has emphasized that its priority is to reduce its low return on income projects. With this new project, an increase in research and development costs will likely offset these previous initiatives to eliminate low return-on-income projects. At the earnings call, Baidu’s management indicated that much of the Ernie-related expenses will be based on the existing engineer headcount.

Even if the chatbot is a success, Wang expects gross margins to still trend lower given the higher computing costs involved.

What is ChatGPT?

Editor's Note: The answer to this question is taken from a conversation with ChatGPT.

ChatGPT is a large language model trained by OpenAI, designed to generate human-like responses to natural language prompts. It is based on the GPT (Generative Pre-trained Transformer) architecture, which uses unsupervised learning to train a neural network on massive amounts of text data, allowing it to learn patterns and relationships in language.

ChatGPT is capable of generating text in a wide variety of styles and genres, including news articles, fictional stories, poetry, and more. It can also answer questions, complete sentences, and even carry on a conversation with a user.

The goal of ChatGPT is to simulate human-like conversation and provide a useful tool for a variety of applications, such as chatbots, virtual assistants, and language translation. 

Will It Take Baidu ‘Too Long’ to Develop Its Chatbot?

“We are cautious on whether Ernie can match the success of ChatGPT so far, given that we have not seen real-time use cases despite the multifaceted ambitions in its incorporation,” Wang said.

Other than cost, Wang also cautions against the duration of the project. Referencing OpenAI’s own experience and timeline with its generative pre-trained transformer, or GPT, it has taken the firm at least five years since its first launch in June 2018 to finalize the latest version for mass users.

How the government is going to regulate these opinion-generative products and commercial use is another primary risk. For now, the OpenAI version is unavailable in China and was banned on Tencent’s social media app WeChat. Several accounts that embedded the bot into an in-app program that offers mainland users proxy access to the uncensored ChatGPT have either been suspended or ceased operations.

The talks of the bot project are yet to be reflected in Morningstar’s equity valuation model. Wang says it remains to be seen whether Baidu’s ChatGPT equivalent is able to deliver what it promises. “We would like to see greater tangibility and use-case for its product on the market before embedding any material valuation in our fair value estimate,’ adds Wang.

Earlier this month, Alibaba Group Holding (BABA), Tencent Holdings (00700), and TikTok owner ByteDance have also touted interest in developing ChatGPT-like services.

What Does This Mean for the Baidu Stock, and the Company?

Baidu and fellow tech giants in China are due to report their first quarterly results since the Chinese government abruptly gave up its zero-COVID approach towards the end of 2022.

The earnings are considered the bellwether of a post-pandemic economy and a gauge for foreign investors’ mood for Chinese assets. Equity and multi-asset managers based in Asia think investors hold a below-benchmark weight in China and are waiting for confirmation of the ‘China’s comeback’ story supported by actual data, for example, earnings and economic indicators.

For the quarter ending December 2022, Baidu posted revenue of RMB 33.1 billion, 3% better than the PitchBook consensus estimate. Its operating margin of 19.6% has also improved. Wang sees Baidu as being on track for a recovery in ad revenues which is expected to be a driver for margin expansion in the latter half of 2023. Despite near-term weakness in advertising sales and a sluggish macroeconomic backdrop, he thinks the long-term thesis of margin expansion remains solid.

“This reinforces our investment thesis that Baidu will expand its operating margin due to the high operating leverage of its advertising business, which is positioned for recovery. We believe that Baidu’s top verticals, including healthcare, travel, e-commerce, and local services, will continue to recover, with low-tier cities leading the pace.”

Optimism over its encouraging results was though partly offset by uncertainty over its long-term plans and costs for Ernie.