INTERNET: Baidu Spending Binge Continues with New iQiyi Tie-Up

Bottom line: A new 1 billion yuan co-production tie-up for iQiyi marks the latest bid by Baidu to build up its new businesses through big spending, but could pressure Baidu’s shares due to shorter-term profit erosion.

iQiyi, Shanghai New Culture in production tie-up

I have to credit Internet giant Baidu (Nasdaq: BIDU) for sticking to its guns with its recent strategy of aggressive spending on acquisitions and tie-ups as the centerpiece of a drive to diversify beyond its core search business. That strategy put a big damper on Baidu’s profit growth in its latest quarterly results, sparking a sell-off that has seen its stock lose more than a third of their value this year.

And yet despite those concerns, Baidu continues to aggressively pour money into its emerging new businesses, many of them companies that are growing fast but are also losing big money. That’s certainly the case with Baidu’s latest investment, which will see it pour 1 billion yuan ($160 milllion) into a new co-production deal between its iQiyi online video unit and a Shenzhen-listed film production house called Shanghai New Culture (Shenzhen: 300336).

This latest deal isn’t really anything new for Baidu or China’s broader online video industry, which is desperately looking for ways to make profits. The most recent trend is for companies like LeTV (Shenzhen: 300104), Youku Tudou (NYSE: YOKU) and iQiyi to develop their own content, either internally or in partnership with other production houses. The goal is to differentiate themselves from each other by offering exclusive programs, thus helping them to attract more loyal viewers.

This latest deal is relatively straightforward, and will see iQiyi invest the 1 billion yuan as part of a broader content co-production agreement with Shanghai New Culture. (Chinese article) The deal has a 5 year duration, and will see the partners cooperate on production of movies, TV series and online games. The tie-up will aim to produce a relatively modest output of at least 2 series and 1 movie each year.

There’s not too much else to say about this particular tie-up, which is the latest in a string of similar moves by video companies to create exclusive content. The move looks smart strategically, as such content will be a critical element for the companies to attract loyal viewers as they try to challenge traditional TV stations.

But the strategy is also quite risky, since it carries huge costs that won’t immediately translate into profits. Youku Tudou is the only separately listed pure online video company, and has become a good example of the kinds of profit erosion these companies face in the short- to medium term. The company has never reported a profit on a regular basis, and in its most recent financial statement said its second-quarter loss more than doubled to 342 million yuan from a year earlier.

Investor Impatience

Investors have grown impatient with Youku Tudou, whose shares have lost around half of their value over the last 3 months, partly due to the massive sell-off on Chinese stock markets. Investors are also growing similarly impatient with Baidu, whose shares dipped 2 percent in the latest trading session after news of the latest tie-up with Shanghai New Culture came out.

In Baidu’s case, investors are growing increasingly worried about the company’s strategy of spending big money to build up its recently acquired businesses in areas like online video, group buying and online travel. Another one of Baidu’s biggest acquired companies, online travel agent Qunar (Nasdaq: QUNR), also has yet to earn sustained profits and has seen its losses steadily balloon to reach 815 million yuan in its latest quarter results, as it fights a bloody battle for market share.

From my perspective, I really do have to admire Baidu for its tenacity in pouring big money into these money-losing companies, despite the investor concerns. Baidu has previously failed to develop new businesses internally, and has had much better success building up companies that it acquires. It’s still not completely clear whether iQiyi or any of Baidu’s other major investments will succeed through this strategy of outspending their rivals. But at least the company is getting some early positive results in this newer diversification drive.

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