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June 16 (The following statement was released by the rating agency)
Fitch Ratings has assigned Baidu Inc.'s (Baidu; A/Stable) US1bn 2.75% senior unsecured notes due 2019 a final rating of 'A'.
The assignment of the final rating follows the receipt of documents conforming to information already received. The final rating is in line with the expected rating assigned on 4 June 2014. The notes are rated at the same level as Baidu's Issuer Default Rating as they constitute direct, unconditional, unsecured and general obligations of the company.
KEY RATING DRIVERS
Dominant Market Position: The ratings reflect Baidu's dominance in the internet search market in China with a traffic market share of over 70% on PC and mobile combined. The company has also achieved a clear lead in China's mobile search market. The ratings also benefit from Baidu's strong profitability and balance sheet, reflecting its ability to generate cash from its proven performance-based, online marketing service that is used by over 700,000 advertisers to reach hundreds of millions of Chinese internet users, and its strong pricing power.
Strong Competitive Advantages: Fitch believes that technological innovation plus high levels of brand recognition and consumer satisfaction enable Baidu to consistently defend its high market share in a rapidly growing market. The company continues to invest to improve natural language processing, deep learning, artificial intelligence, image recognition, voice technology, use of big data, location-based services and mobile search, further strengthening its technology leadership. It also has nurtured good relationships with the government and regulatory bodies.
Solid Performance: Baidu's revenue grew 59% yoy in 1Q14, driven by robust mobile traffic growth, continued adoption of its mobile search products and enhanced monetisation of these products. Mobile revenues accounted for over 20% of 1Q14 revenues. EBIT margin fell to 25% in 1Q14 from 35% in 2013, reflecting increased spending on channel and marketing, infrastructure, content and traffic acquisition to strengthen its market position in the mobile arena. Fitch expects Baidu's margin to recover after the transition to develop its mobile platform. Strong Cash Generation: Baidu generated free cash flow (FCF)/sales of over 30% for 2008-2013. Including short-term investments, where the company parks its surplus cash, Baidu had unrestricted cash of CNY8.8bn and near cash of CNY30.9bn at end-March 2014, which together is equivalent to 219% of its total debt. Fitch expects Baidu to maintain strong financial flexibility and ample liquidity over the medium term.
Foreign Ownership Restrictions: Chinese law restricts foreign equity ownership of internet, online advertising and employment agency companies in China. Baidu operates its websites in China through contractually controlled consolidated, affiliated Chinese entities. These variable interest equity (VIE) arrangements are the usual mechanism for overseas investors to participate in China's restricted sectors and are a credit weakness as they may not be as effective in providing control as direct ownership or may face legal challenges in the future.
VIE Weaknesses Mitigated: Baidu generates over 70% of revenues from, and keeps almost all the cash and assets within, its wholly owned subsidiaries in China rather than at the contractually controlled, consolidated affiliated entities.
Fitch is reassured by the alignment of Baidu's and the affiliates' objectives and the company's continuing good relationship with the government and regulatory authorities.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- evidence of greater government, regulatory or legal intervention leading to an adverse change in the company's operations, profitability or market share
- decline in operating EBIT margin to below 10% (35.0% in 2013)
- decline in pre-dividend FCF/sales ratio to below 10% (31.7% in 2013)
- increase in funds flow from operations-adjusted leverage to above 2x (1.7x for 2013)
Positive: For the short-to-medium term, Baidu's rating is at its ceiling and takes into account Fitch's expectation of profit growth. Fitch may consider an upgrade if the company develops businesses that materially diversify cash generation away from operations that are subject to Chinese government and regulatory risk, provided such diversification does not damage the company's financial profile.