December 2, 2016 / 9:05 AM / 8 months ago

Fitch Affirms Baidu at 'A'; Outlook Stable

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(The following statement was released by the rating agency) HONG KONG, December 02 (Fitch) Fitch Ratings has affirmed China-based Baidu, Inc.'s (Baidu) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) of 'A' and foreign-currency senior unsecured rating of 'A'. The Outlook is Stable. A full list of rating action is at the end of this commentary. KEY RATING DRIVERS Leading Market Position: Baidu's ratings benefit from its dominant market position in China's internet search engine. The company held a revenue market share of about 80% in 2015, according to iResearch. We expect Baidu to remain the platform of choice for advertisers to promote their products on search engines in China. Technological innovation plus high levels of brand recognition and consumer satisfaction have enabled Baidu consistently to defend its high market share. Rules Inflict Short-Term Pain: We expect China's implementation of new online advertising regulations and Baidu's higher, self-imposed standards on verification of its customers to put pressure on Baidu's profitability in the short term. However, the more stringent measures should help restore consumer confidence and foster healthier development of China's internet industry over the longer term. Given its strong competitive advantages in scale-based network effects and technology innovation, we expect Baidu's profitability to recover gradually in 2017. Substantial Losses in New Businesses: We expect substantial losses in Baidu's new businesses to continue to weigh on the company's profitability in the next two to three years. However, we believe Baidu will take a disciplined approach to expenses and focus on return on investment. In addition, the high profitability of its search services should help cushion the losses from new businesses. In 3Q16, transaction services and online video services reduced Baidu's non-GAAP operating margins by 21.4 and 7.7 percentage points respectively. Solid Cash Generation: We expect solid free cash flow (FCF) generation from Baidu's search services, although cash generation in 2016 may be affected by the new online advertising regulations and Baidu's enhanced customer verification process. We expect operating cash flow (CFO) from its search services to remain strong and help stabilise the company's overall FCF margin at 15%-20% over the longer term. Baidu's FCF margin has remained relatively high, although it dropped to 18% in 2015, from 20%-45% in 2012-2014. 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. The alignment of Baidu's and its affiliates' objectives and the company's continued good relationships with the government and regulatory authorities mitigate the risks from the variable interest entity (VIE) arrangements. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Baidu include: - Revenue growth of about 6% in 2016 and 15%-20% in 2017-2018 - Operating margin, excluding share-based compensation, at 14%-15% in 2016-2017 before improving to 19% in 2018 - Annual capex of CNY7bn-8bn in 2016-2018 - No cash dividend and the USD2bn share buyback programme to be completed by end-2017 - Strong liquidity position to be sustained in 2016-2018 RATING SENSITIVITIES 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 - Material loss of market share in key products and services - Significant M&A that negatively affect the operations or the business profile - Sustained decline in operating cash flow - operating EBIT margin sustained below 10% (2015: 20%) - a shift to more aggressive financial policies, for example a sustained loss of its net cash position or sustained funds flow from operations (FFO)-adjusted leverage above 2.0x (2015: 3.1x). However, FFO-adjusted leverage rising above this target alone will not lead to a downgrade should the company retain its strong net cash position and high FCF margins. Positive: The ratings take into account Fitch's expectation of profit growth and a positive rating action is unlikely in the medium term. The agency may consider an upgrade if the company develops businesses that materially diversify cash generation away from current operations, provided such diversification does not damage the company's financial profile. LIQUIDITY Ample Liquidity: We expect Baidu to continue to maintain a large net cash balance. At end-September 2016, Baidu had cash and short-term investments of CNY78bn. This compared with total debt of CNY40bn, which included redeemable non-controlling interests at subsidiaries. In addition, the company arranged USD2bn of syndicated loan facilities in 1H16, of which only USD500m was drawn down as of September 2016. FULL LIST OF RATING ACTIONS Long-Term Foreign-Currency IDR affirmed at 'A'; Outlook Stable Long-Term Local-Currency IDR affirmed at 'A'; Outlook Stable Foreign-currency senior unsecured class rating affirmed at 'A' USD750m 2.250% senior notes due November 2017 affirmed at 'A' USD1bn 3.250% senior notes due August 2018 affirmed at 'A' USD1bn 2.750% senior notes due June 2019 affirmed at 'A' USD750m 3.000% senior notes due June 2020 affirmed at 'A' USD750m 3.500% senior notes due November 2022 affirmed at 'A' USD500m 4.125% senior notes due June 2025 affirmed at 'A' Contact: Primary Analyst Kelvin Ho Director +852 2263 9940 Fitch (Hong Kong) Limited 19/F., Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Shelley Jang Director +822 3278 8310 Committee Chairperson Steve Durose Senior Director +61 2 8256 0307 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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