Revenue is nearly flat. Why is the profit outlook notably weaker?

  • Morgan Stanley expects Baidu’s core revenue in the third quarter of 2026 to be 24.85 billion yuan, up 0.8% year on year and 1.2% above the Visible Alpha consensus; core non-GAAP operating profit, however, is expected to be just 1.62 billion yuan, down 27.4% year on year and 30% below consensus. The gap in expectations is mainly in profitability rather than revenue size.
  • The bank expects the core non-GAAP operating margin to fall to 6.5%, below 9.0% in the same period last year, 15.2% in the second quarter and the consensus estimate of 9.4%. Weak core revenue growth combined with increased research and development and AI spending is the main reason for pressure on profit.

Why can cloud growth only support revenue?

  • Morgan Stanley expects third-quarter AI cloud infrastructure revenue of approximately 8.27 billion yuan, up 97% year on year, a marked acceleration from 49% growth in the second quarter. GPU cloud revenue is expected to maintain triple-digit growth, with demand for GPU rentals remaining the main driver.
  • Meanwhile, core advertising revenue is expected to be 11.93 billion yuan, down 22% year on year, a deeper decline than the 19% recorded in the second quarter. Advertising still accounts for approximately 48% of core revenue. The weak macroeconomic environment is weighing on this large business, meaning rapid cloud growth is mainly filling the advertising shortfall.
  • The bank remains cautious about a near-term improvement in advertising: advertising recovery in offline industries is slower than expected, and search also faces disruption from AI; it will also take time for AI commercialization to make a significant contribution to overall financial performance.

How does AI spending affect both profit and cash flow?

  • At its last earnings call, management said it would hire more key AI talent, bring the ERNIE model to an industry-leading level, and expand computing capacity to more than 2 GW over the medium to long term. The first two involve spending on talent and research and development, while computing capacity expansion brings higher capital expenditure.
  • Morgan Stanley raised its 2026 capital expenditure forecast from 24 billion yuan to 35 billion yuan; capital expenditure in 2025 was approximately 12 billion yuan. It also cut its core non-GAAP operating profit forecasts for 2026 and 2027 by approximately 13% and 7%, respectively.
  • The time needed to recover investment is also lengthening: the bank’s discounted cash flow model for the core business projects unlevered free cash flow of negative 19.14 billion yuan in 2026, remaining negative through 2029 and turning positive only in 2030. Accelerating cloud revenue and continued cash investment coexist in the model.

Price target cut: What changed in the assessment?

  • Morgan Stanley maintains its Underweight rating and cuts its price target from 80 dollars to 70 dollars. In its sum-of-the-parts valuation, the core business value falls from 74 dollars to 65 dollars per share, and the value of investments in associates falls from 6 dollars to 5 dollars.
  • The 11% discount rate and 3% perpetual growth rate in the core business DCF are unchanged. The valuation cut reflects a weaker outlook for profit and cash flow rather than a higher discount rate; the 70 dollar price target implies approximately 9 times expected 2027 non-GAAP earnings.
  • The bank still expects Baidu to pay its first dividend before year-end, with total cash returns of approximately 1 billion to 1.5 billion dollars. Its rating remains driven, however, by a limited advertising recovery and the continued near-term drag on earnings from AI spending.