INTERNET: Baidu Pays $1.3 Bln Price for Transparency

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Bottom line: Baidu’s long-term revenues will decline by 15-20 percent from current levels as a result of a cut-back in sponsored links and new transparency policies that will scare away some of its advertisers. 

Baidu cuts Q2 revenue outlook

What’s the cost of being honest, or at least a little more honest? If your name is Baidu (Nasdaq: BIDU), apparently the answer is about $400 million, which is how much China’s leading search engine has just lowered its latest quarterly revenue forecast after taking steps to become more transparent. Put differently, the figure is about one-eighth of Baidu’s previous revenue forecast for the quarter, meaning it would translate to lost revenue of about $1.3 billion of the $10.25 billion it generated for all of last year.

Put yet another way, the latest forecast for second quarter revenue of 18.1 billion to 18.2 billion yuan, or about $2.8 billion, represents a meager growth rate of 9 percent from the second quarter of last year. That would easily be Baidu’s slowest growth ever, and compares with usual growth figures of 30 percent or higher. But much has happened in the last month as Baidu is being forced to become more transparent about its advertising practices following a major scandal.

One interesting sidebar to all of this is where exactly the lost revenue will go. After all, the $1.3 billion in revenue that Baidu will lose from advertisers will have to go somewhere, and could potentially benefit someone else. Other groups that could gain may include more traditional advertising-dependent companies such as web portals Sina (Nasdaq: SINA) and online video companies like Youku Tudou. One of the biggest beneficiaries could be Sohu (Nasdaq: SOHU), since it runs a major web portal, a large video service and also a rival search engine that could pick up some of this lost business from Baidu.

But let’s return to our main story for now, which is the somewhat shocking revelation that Baidu’s newly rolled-out system for providing more transparent search results will cost it an eighth of its previously forecast revenue for the second quarter. (company announcement; English article; Chinese article) Quite revealingly, a search on Baidu’s name on its own popular news page returns a message that says “sorry, the page you are looking for can’t be found,” indicating Baidu has censored the news for its own readers.

Forced Reform

But then again, the sudden move to become more transparency was hardly Baidu’s own choosing, so it’s not too surprising it doesn’t want to publicize this big blow to its revenue. For anyone who hasn’t followed the story, Baidu landed at the center of a major scandal last month over the tale of a young cancer patient who selected a hospital for treatment partly based on its high placement in results on a Baidu search. (previous post)

The patient, Wang Zexi, later died, but not before complaining loudly when he learned that the hospital was ranked so highly simply because it paid the highest fee in Baidu’s online advertising auction system. Baidu didn’t clearly state that relationship at the time, but has begun clearly disclosing which of its search results are paid after being ordered to do so by several government regulators.

Hospitals have always been one of Baidu’s biggest customer groups, which created big investor concerns after a high-profile spat last year between Baidu and the nation’s largest hospital association. (previous post) I suspect that many of its lost advertisers now are such hospitals, since disclosing the paid status of their claims in search results automatically undermines the credibility of those claims.

The bigger question is what longer term impact Baidu’s more transparent system will have on its performance. Baidu didn’t change its system until mid-May, or midway through the second quarter. That means the impact of the revenue downgrade could have been twice as big if the modifications came at the start of the quarter.

Baidu also notes that it has cut down its volume of sponsored links, and that some of its advertisers have temporarily withdrawn their business until they can comply with new guidelines rolled out by regulators after the scandal. At the end of the day, a long-term revenue loss in the 15-20 percent range is probably reasonable, though we’ll have to wait until the second half of the year to see how big the decline really is.

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