We maintain our Market perform recommendation on Baidu following its strong 1Q23 results. Baidu posted a solid beat in revenues and EBITDA, and maintained its healthy leverage metrics. Baidu maintained its good cost controls, which led to a better EBITDA margin and improved FOCF in 1Q23. We expect Baidu to maintain healthy debt metrics in FY23, and believe the company is well positioned to benefit from China’s macro recovery. Management sees continued recovery of online advertising in 2Q23 and opportunities in generative AI.

However, we think Baidu’s $ bonds are expensive compared to Alibaba and Tencent. For those seeking exposure to Baidu, we prefer Baidu short-end (24, 25s, 26) on a total return basis, as its yield curve is relatively, and we prefer Baidu 26 and 30s for spread investors.

Any regulatory clampdowns abroad and domestically (e.g. potential US investment ban, antitrust rules, data security and personal information protection laws) may adversely affect the business of Baidu. The interpretation of Chinese laws and regulations involves some degree of uncertainty.

There are regulatory risks given the corporate structure which uses variable interest entities (VIEs) to circumvent China’s restrictions on foreign ownership of Internet Content Providers (ICPs).

Baidu has made significant investments into long-term AI-related projects, which may take time to turn profitable. A potential escalation of the US chip restriction could have a material negative impact its AI related business (ie. cloud, ernie bot, autonomous driving).