Blue Lotus

August-September 2022
Shawn Yang, managing director at Blue Lotus Capital Advisors, discusses Baidu and TME’s recent quarterly earnings with CNBC on Aug 31st and Sep 15th, respectively. We still maintain a BUY rating for Baidu and HOLD rating for TME.

CNBC interview on Aug 31st
 Q: Thank you very much on joining us on Baidu’s earnings. What are your first takeaways from the numbers overall and the outlook? Especially with their investment going into AI and EVs, do you think they are late in the game?
 
Yang: I think the first takeaway is that it’s very similar to most of other Chinese internet companies that basically have a very bad performance in terms of the revenue in the second quarter, which is mainly caused by COVID. There’s a lot of cost savings, so usually we’ll see a very good performance in terms of profits. Now in terms of Baidu, its online marketing or the ads revenue seems to be recovering very slowly. The company is mainly focusing on autonomous driving and AI technologies. You mentioned that some investors may feel that it’s a little bit late. This concern may have some reasons because the Chinese autonomous driving or EV sectors has seen a rapid growth for the past two years. There are tons of new companies rising up, and Baidu is more focused on providing Apollo, smart driving AI cloud or this kind of infrastructure works. So probably this is going to be a long-term investment and a new business opportunity for Baidu. It would probably begin to contribute revenue in a very late stage.
 
Q: What can Baidu do about it? Since the ads business is sorted, and I don’t know how much it actually gets impacted by consumer slowdown, but AI and the cloud platform as well as the autonomous driving platform, those will get impacted as supplement. In that standpoint, what are they buying into for the future?
 
Yang: First of all, it definitely is about recovery, because if you look at Baidu, its main ads format is search ads, so it’s very unique. And if you look at the whole competitive landscape, there are a lot of short videos and newsfeed ads. But there isn’t another platform that could be compared by Baidu that can provide very precise search results. The other thing about AI and the autonomous driving is that Baidu would often announce some achievements. For example, for the ACE Smart Transportation, which is basically helping the local governments to build up transportation infrastructure. Baidu says that they expect this segment to breakeven in the next couple of quarters. And also Apollo Go, their robotaxis services, has reached 1mn accumulated rides. But again, I think these are very early stages for the AI. And I think that monetization will also happen very late, because a lot of these autonomous driving and EV business need a lot of experiments. And there’s going to be a lot of business testing before it can be fully commercialized.
 
Q: Baidu is known as China’s answer to Google. It dominates in the search engine with a 75% market share. But we’re now talking about and looking ahead to its venture into autonomous driving into the production of Robocars and robotaxis. Let’s talk about Apollo Go first because they reached a milestone of 1 million rides. They’re available in about 10 cities. Where do you see the development in the robotaxis?
 
Yang: Actually, there are a couple of Robotaxis in Shenzhen, and my experience is that, it definitely cannot be fully 100% compared with taxis with human drivers, because it pauses and stops frequently. So the technology still needs some time to develop. The other barrier is always about policy and regulation. And I think it’s very similar in the US and other countries. People are going to ask that what if there are accidents and who should take the responsibility? If you look at its latest Robotaxi type RT6, they promoted the cost per unit is roughly about 250k RMB. So, it’s similar compared with other taxis. But again, I think that there are some concerns from the user side and the regulation side. Definitely, I think that it’s going to be a very brand-new technology. And I believe a lot of people will be glad to use Robotaxi if that’s safe enough, and the cost can be low enough. So I think it’s going to be a promising technology in future. But again, it’s not like internet that can be wrapped up very quick. The technology needs some time to test, develop, cumulate enough data. So probably we are going to see some real achievements in the next two to three years.
 
Q: Baidu has invested $400 million into a joint venture with Geely. This is known as JIDU. Talking now about the production of Robocars and the Guangzhou Auto Show coming up a little bit later this year, do you expect them to be unveiling any new vehicles? And in terms of production, how quickly will they be able to get this on market?
 
Yang: I think the problem is that when it comes to cooperation, there are sometimes conflicts between two sides. So if you look at the whole China EV market, there have been two waves. The first one was Nio, Xpeng and Li Auto. And this year, I think there’re more traditional car manufacturers that are raise up very quickly, and are also promoting their cars. So I think the problem for JIDU is that even though they can launch some experimental models, it’s actually very difficult to project how long they could put these into massive production and finally to the markets. So I think that the China EV market is growing very fast. It’s also changing very fast. So both Baidu, JIDO, and Geely need to push these projects a little bit faster; Otherwise, the market will be full of competitors.
 
Q: Now the China tech players were under pressure given the delisting risk, there have been some developments in this regard. Do you expect Baidu to potentially have a primary listing here in Hong Kong, to continue with the dehedging risks?
 
Yang: I think everybody is considering primarily listing in Hong Kong. That’s just to hedge the risk, even though I think there has already been some agreement. People are a little bit more positive about that. But from an enterprise perspective, if you are Robin Li, CEO of Baidu, then probably the first thing you think is that I need to hedge that risk. So how to do that? The best way, if you look at other peers, they all do the same thing. That’s to do the primary listing in Hong Kong because that would diversify your investor base and hedge the risk. So, I would expect that most of other Chinese companies will follow that strategy.
 
Q: Warren Buffett is trimming BYD stake, is that raising a red flag for the whole EV industry in the mainland?
 
Yang: First of all, my understanding is that EV is a sector that has long potential so there will always be some ups and downs to EV stocks. But if you look at the low penetration, if you look at the users gradually get accustomed to EV, so I think this sector has long potential, but I will not be surprised if there will be some ups and downs for individual loss.
 
CNBC interview on Sep 15th
 Q: In terms of what this means for capital floating, are they going to be impacted at all by this newest thing?
 
Yang: I think that definitely a lot of companies have been doing similar things, but it's more about the company's fundamentals. We have a hold rating for Tencent Music Group. If you look at the revenue, it is down roughly about 10% to 15% this year. Through cost-savings, their profits probably could decrease by 3%-4% YoY. I think they are facing a lot of challenges in upcoming quarters.
 
Q: We have seen many companies come to market by way of introduction. So TME would be in good company following the likes of Nio as well as OneConnect, both of these are Chinese companies that are also listed in the United States. Another point of news that we have seen and we've been watching in particular for Tencent is just yesterday they finally got a gaming license. This is after a suspension for the last 15 months as it was resumed in April of this year. Finally, Tencent and NetEase both manage to get gaming licenses , what do you expect looking forward to the gaming portion of their revenues. How are they going to be doing?
 
Yang: It's definitely something positive for both Tencent and NetEase. I think Tencent is gaining a game code approval through an investing company. But anyway, I think that means that the regulation is going to be into a more regular period. I think Tencent and NetEase, they don't have game code approval for nine months or something. So they are going to receive more game code approval. It’s definitely good news for their new games. But I think the problem is that China's mobile gaming market's penetration is already very high and the player's demands are also increasing a lot. So a lot of Chinese gaming companies are actually moving R&D and marketing resources to overseas markets. So I think the next battle for Tencent and NetEase is probably the overseas market instead of China's domestic market.
 
Q: Did I hear you correctly that you think for Tencent Music it's gonna be very challenging for the next few quarters in which case it begs the question of whether now is actually a good time to list in Hong Kong?
 
Yang: I think the main purpose of listing in Hong Kong is mainly to hedge the risk, the geopolitical risk. So that's why you have seen a lot of companies, especially internet companies doing similar things. They want to diversify their investment, investors’ base and backgrounds and also get enough cash to go through the tough period. As for Tencent Music Group, if you look at their financial reports, their monthly paying users have been flat for quite a period of time and they're also facing a lot of competition from short video apps like Douyin. They have some new initiative businesses like long-form video. But I think at least now that all these new initiative businesses are pretty small.
 
Q: So I wanted to talk to you a little bit about what Tencent's doing when it comes to gaming because a lot has been said about the stakes that are potentially selling down but they are getting aggressive when it comes to acquisitions in that space. Do you think that they're really trying to position themselves to be one of these big players in the industry because there are a number of targets, a number of consolidation players that are happening right now. If you look at Activision, you look at what Sony is doing. Can Tencent compete with the likes of them on the IP Front?
 
Yang: Yes, they can do that. And I think a good thing for Tencent is that they're very strong in terms of converting console game and PC game to mobile game. And if you look at the success of <Call of Duty Mobile> and also the <PUBG Mobile>, you see that Tencent is showing that capability. But I think the problem for Tencent is that it simply becomes a little bit cautious in terms of acquisition. It used to be very aggressive, but now I think that they simply slow down the pace because their core business is under a lot of challenges. So that's why I think they probably are going to slow down the pace of investment or acquisition in the next few years.
 
Q: We were reporting about the Tencent raising its stake in Ubisoft. This is the French gaming publisher. It was $198 million deal giving it an 11.3% stake in that company. Now as you're expecting it to slow down acquisitions, what about its divestment? Because it was also reported widely that in its divestment strategy now they want to sell out $112 billion in various companies. The last time we had you on, we heard that in their earning releases they said the report about Meituan was not correct. But what other companies do you think that they might have on the list where they want to lessen their exposure?
 
Yang: That's a tough question to answer because you know it's purely my personal speculation. I think that Tencent will review all the investment portfolio and see if any company is in tough situations or not so matched with their core strategy probably will be on the list. The other thing is that Tencent probably is going to review some of its investments, for example, in e-commerce or local service. These areas are a little bit far away from Tencent's current core businesses like advertising and gaming. I would expect Tencent to strengthen its position in areas such as gaming, advertising and overseas traffic. But if some other areas or companies are a little bit far away from its core business, it’ll probably consider reducing the shares