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Moodys Lowers Outlook on Baidu.com (BIDU) to Stable; Affirms Ratings

May 13, 2016 9:38 AM EDT

Moody's Investors Service has changed to stable from positive the outlook on Baidu Inc.'s (Nasdaq: BIDU) A3 issuer rating.

At the same time, Moody's has affirmed Baidu's A3 issuer and senior unsecured debt ratings.

A full list of the affected ratings and outlook on bonds issued by Baidu can be found at the end of this press release.

RATINGS RATIONALE

"The change in the rating outlook to stable reflects Moody's expectation of weaker revenue growth over the next 12-18 months for Baidu due to the controversy related to the way it posted medical advertisements," says Lina Choi, a Moody's Vice President and Senior Credit Officer.

"As a result of the anticipated weaker revenue growth, Baidu's credit metrics are less likely to strengthen over the next 12 months to levels above those expected for its A3 rating," adds Choi.

In this context, Moody's estimates that Baidu's revenue growth rates will slow to 15%-17% in 2016 and 2017 from 35% in 2015. EBITDA will also grow more slowly to RMB24-28 billion from RMB21 billion in 2015.

The estimated 2016-2017 figures include the margin improvement due to the full deconsolidation of Qunar (unrated), the company's loss-making online travel service subsidiary. The deconsolidation occurred with Baidu selling down its stake in mid-October 2015.

Baidu's total debt will also likely rise to RMB45 billion by end-2016 to support its business growth after having had increased to RMB42 billion at end-2015.

Therefore, adjusted debt/EBITDA will stay around 1.7x-1.8x over the next 12 months. Such levels are not substantially far from 2.0x at end-2015 and are weak for any rating upgrade.

In summary, Moody's sees a negative -- but limited -- impact on Baidu's reputation and revenue from the death of a college student who had sought medical treatment based on the company's paid-for-performance search results.

Baidu has indicated that it will implement remedial measures to repair its reputation after investigations by the Cyberspace Administration of China, the State Administration of Industry and Commerce, and the National Health and Family Planning Commission.

Baidu's revenue from the healthcare industry is also likely to be negatively impacted in the near term, but -- as a mitigating factor -- its customer base is diversified.

On the other hand if the company's revenue and credit metrics deteriorate beyond Moody's expectations, then its ratings would come under pressure.

Baidu's A3 rating reflects its position as the leading Chinese language Internet search engine and the largest provider of online advertising in China. It also reflects China's favorable industry growth trends and large addressable market. There is opportunity for Baidu to show sustainable growth in user traffic and online advertising revenue.

The rating takes into consideration Baidu's steady free cash flow (FCF) generation and strong liquidity position, such that it has sufficient financial resources to support its acquisitions and development of new products and services for evolving Internet technologies and user preferences.

In addition, the rating is also supported by the company's conservative financial management and disciplined acquisition appetite, which have resulted in low debt leverage and a strong net cash position.

However, the rating is constrained by (1) the competitive state of China's Internet market; (2) rising acquisition risks relating to the company's efforts to build a full mobile platform; and (3) regulatory and legal risks for the company's business and corporate structure.

As indicated, Baidu's net cash position remains strong. Cash and short-term investments totaled RMB68.4 billion at end-2015, covering well its reported short-term debt of RMB1.9 billion. Moody's expects the company to maintain its net cash position over the next 12 months.

The stable outlook reflects our expectation that Baidu will (1) maintain a leading position in China's Internet search engine market; (2) continue to generate strong positive revenue growth; and (3) maintain its strong financial profile.

Upward rating pressure is limited in the near to medium term. However, the rating could be upgraded over the longer term if the company (1) demonstrates that it can execute the required changes in its business practices and concurrently achieves solid revenue and cash flow growth; (2) maintains its operating performance and financial conservatism, including debt/EBITDA below 0.75x-1.0x; and (3) achieves a strong balance sheet with a solid net cash position.

On the other hand, downward rating pressure could arise if the company (1) fails to abide with the operational changes required by regulators, or experiences a substantial decline in market share in the process of executing such changes, which could affect its revenue growth and/or cash flow generation; (2) experiences difficulties in sustaining its business model, which could lead to substantial declines in profitability or liquidity; (3) deviates from its current conservative financial policies; or (4) engages in aggressive acquisitions that could pressure its balance sheet liquidity or raise its overall risk profile.

Financial indicators for a downgrade include debt/EBITDA above 1.5x-2.0x or the inability to sustain a net cash position.

Furthermore, negative developments in the regulatory regime that could affect Baidu's operations or business model will be negative for the rating.

The principal methodology used in these ratings was Business and Consumer Service Industry published in December 2014. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.



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