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Forget Sogou, Baidu Is a Better Chinese Tech Stock

Sogou (NYSE: SOGO), which owns China's second-largest search engine and its top mobile keyboard app, recently turned heads with its expanding user base and stabilizing profits. Its revenue and adjusted earnings rose 1% and 44%, respectively, last quarter, as daily active users on its Mobile Keyboard app grew 9% to 464 million.

Sogou also expects its first-quarter revenue, which bears the full impact of the COVID-19 outbreak in China, to rise 3% annually at the midpoint. That was much rosier than Baidu's (NASDAQ: BIDU) forecast for a 9% decline in the first quarter.

Investors might be wondering if Sogou is a better Chinese tech stock than Baidu, which dominates China's search market but is struggling to keep pace with rivals like Tencent (OTC: TCEHY), ByteDance, and Alibaba (NYSE: BABA), which runs its e-commerce marketplaces as advertising platforms. Sogou is certainly getting its act together, but I still think Baidu remains a better long-term investment, for five simple reasons.

Image source: Getty Images.

1. Baidu spends less money on traffic acquisition costs

Baidu spends less than a fifth of its ad revenue on traffic acquisition costs (TAC). Sogou's TAC consumed nearly half of its search and ad revenue last quarter. Baidu spends less money to attract traffic because it's already one of the default platforms for many advertisers. Baidu controlled 73% of China's search market in March, according to StatCounter, compared to Sogou's 15% share.

Sogou is gradually reducing its TAC, but lower spending could leave it more vulnerable to Baidu as the Chinese economy gradually recovers. If Sogou ramps up its spending, its non-GAAP operating margin of 14% last quarter -- which is lower than Baidu's comparable operating margin of 23% -- could crumble.

2. Baidu is expanding its voice search ecosystem

Sogou's Mobile Keyboard is the most popular input app for Chinese characters in China. Sogou added voice searches to the platform, and its daily voice queries surged 54% annually to over 800 million last quarter. It also sells hardware devices, including AI-powered voice recorders, which tether more users to that ecosystem.

Image source: Getty Images.

However, Baidu aggressively countered Sogou's growth with its voice assistant DuerOS. Monthly voice queries on DuerOS more than tripled annually to over 5 billion last quarter, and queries on its Xiaodu smart speakers surged seven-fold to 2.3 billion.

Baidu's Xiaodu speakers also overtook Alibaba's Tmall Genie speakers as the best-selling speakers in China last year. Sogou doesn't have a meaningful presence in that high-growth market yet. Baidu is also tethering connected cars and smart home devices to DuerOS, which could expand its search ecosystem far beyond PCs and mobile devices.

3. Baidu has a "best in breed" AI platform

Sogou is touting its AI platform, which currently powers its voice queries and recording devices, as a new growth engine. However, Sogou's AI efforts pale compared to Baidu's AI business, which is backed by the Chinese government.

In 2017, China's Ministry of Science and Technology split the first wave of open AI technology contracts between Baidu, Alibaba, Tencent, and iFlytek. It assigned Baidu to driverless technologies, Alibaba to handle smart cities, Tencent to digital healthcare, and iFlyTek to voice recognition technologies. In other words, Baidu will remain one of the top Chinese AI stocks for the foreseeable future.

4. Baidu's answer to WeChat

Baidu's monthly active users for its Mini Programs, which offer various services from within its mobile app, soared 114% annually to 316 million last December. That audience is notably smaller than the 1.16 billion monthly active users on Tencent's WeChat, which offers similar Mini Programs for payments, e-commerce orders, and other services.

However, Baidu is still catching up as a viable alternative to WeChat's "all-in-one" platform. Baidu's Mini Program ecosystem could keep growing as users spread their digital lives across multiple platforms instead of relying completely on WeChat accounts -- which could be abruptly suspended by the Chinese government over offending social media posts. That expansion would complement the expansion of Baidu's voice, AI, and driverless platforms. Sogou can't expand its ecosystem in comparable ways yet.

5. The growth of iQiyi

Baidu relies heavily on the growth of the video streaming platform iQiyi (NASDAQ: IQ) to offset its slower growth in ad revenue. iQiyi remains unprofitable, but its margins are improving -- its paid subscribers grew 22% annually to 106.9 million last quarter.

iQiyi and Tencent Video are the two most popular video streaming platforms in China. Usage of both platforms likely rose throughout the lockdown period in February. As iQiyi expands, it could tether more viewers to Baidu's other services -- including DuerOS, smart speakers, and its mobile app -- and feed more data to its targeted ads.

Sogou doesn't own a video platform. Instead, it pulls videos from other platforms, including its former parent company Sohu (NASDAQ: SOHU), in its online search results. This blind spot in its ecosystem could become a liability as more advertisers favor video ads.

The bottom line

Sogou is still a decent speculative stock, but it has fewer growth engines, lower margins, and less market clout than Baidu. Both stocks trade at similar valuations, but Baidu is easily the safer long-term investment in this wobbly market.

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Leo Sun owns shares of Baidu and Tencent Holdings. The Motley Fool owns shares of and recommends Alibaba Group Holding Ltd., Baidu, and Tencent Holdings. The Motley Fool recommends iQiyi and Sohu.com. The Motley Fool has a disclosure policy.


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