How much of the advertising decline can cloud growth offset?

  • JPMorgan expects Baidu's AI cloud infrastructure revenue to reach approximately 8 billion yuan in the third quarter of 2026, up approximately 90% year over year and approximately 10% quarter over quarter; the year-over-year growth rate exceeds the second quarter's 50%. An approximately 3.7 billion yuan year-over-year increase in cloud revenue can cover an approximately 3.1 billion yuan decline in online marketing revenue, returning Baidu Core revenue to slight year-over-year growth.
  • The 90% year-over-year growth rate includes a low-base effect: cloud infrastructure revenue fell from 4.9 billion yuan in the preceding quarter to 4.2 billion yuan in the third quarter of 2025. The bank therefore places greater weight on this quarter's approximately 10% quarter-over-quarter growth and has not reinstated the cloud business's valuation premium over peers, which it previously removed.

Why could profit fall further even as revenue stabilizes?

  • The bank expects third-quarter group non-GAAP operating profit of approximately 1.6 billion yuan, down 27% year over year and more than half below the approximately 3.8 billion yuan recorded in the second quarter. The loss of high-margin advertising revenue, depreciation from the second quarter's 11.4 billion yuan in capital expenditure, and spending on data, talent and computing power for model training are simultaneously squeezing profit.
  • Pressure on advertising is also related to the AI search overhaul: AI answers occupy space on search pages, crowding out ad slots and increasing computing costs, while Baidu has deferred monetization to protect the user experience. JPMorgan expects advertising revenue to keep falling through the fourth quarter and sees little prospect of a change in monetization strategy before the company sets its 2027 plan; although the fourth-quarter margin may recover, it is unlikely to return to the second-quarter level.

Why might the cloud business recover cash faster?

  • JPMorgan believes demand for high-end GPU computing power exceeds supply, leading more customers to pay upfront to secure resources, while contract terms have lengthened from about one year to two or three years. Cash received before service delivery can fund some new purchases and shorten the interval between investment and cash collection.
  • Baidu can also redirect computing capacity purchased earlier at lower prices, some of which was previously used internally, to external customers. The additional revenue therefore does not require an equivalent amount of new capital expenditure.
  • Long-term contracts also have costs: prices may be locked below future spot prices, and rising storage costs will squeeze margins if they cannot be passed on. The bank expects Baidu to reject long-term contracts with excessively thin margins; changes in customer prepayments and deferred revenue are important indicators of improving cash collection.

Does lower capital expenditure relieve the cash pressure?

  • Second-quarter capital expenditure of 11.4 billion yuan was substantially higher than operating cash flow of 3.4 billion yuan, and total borrowing increased by approximately 14 billion yuan in the first half. JPMorgan expects third-quarter capital expenditure to fall below 8 billion yuan and operating cash flow to remain positive for a fifth consecutive quarter, but positive operating cash flow and covering capital expenditure are two different things.
  • Given that prepayments support purchases and domestic bank credit costs are relatively low, the bank believes there is no need for a share placement or convertible bond issuance and maintains a 20% discount to net cash value. If third-quarter AI cloud infrastructure capital expenditure is below 7 billion yuan, the bank will use whether GPU cloud revenue growth exceeds 100% to distinguish improved capital efficiency from weakening demand.

Why maintain Overweight despite a sharp earnings downgrade?

  • JPMorgan lowered its non-GAAP net profit forecasts for 2026 and 2027 by 15% and 42%, respectively, with the latter year particularly affected by a higher depreciation assumption. Its June 2027 price target was cut from 175 dollars to 145 dollars per ADS, and its Hong Kong share target from 170 Hong Kong dollars to 140 Hong Kong dollars.
  • GPU cloud and Kunlunxin remain the basis for the Overweight rating. AI-native marketing and traditional search, the businesses affected by this earnings downgrade, account for only approximately 13% of the bank's sum-of-the-parts valuation, so the price target reduction is smaller than the earnings forecast cuts.
  • Kunlunxin confidentially filed an application for a Hong Kong listing in January 2026, but there is no public timetable. The bank's valuation assumes neither a listing date nor a distribution of equity to Baidu shareholders; progress toward a listing is an additional catalyst.