Baidu, Inc. (BIDU, BUY) - 3Q26 Preview: AI Cloud Accelerates, but Ad Weakness and AI Investment Weigh on Earnings; Maintain BUY but Lower PT to $115

Baidu, Inc. (BIDU, BUY) - 3Q26 Preview: AI Cloud Accelerates, but Ad Weakness and AI Investment Weigh on Earnings; Maintain BUY but Lower PT to $115

We maintain our BUY rating on BIDU but lower our price target to $115 from $160, reflecting weaker near-term profitability and a more conservative valuation. We expect 3Q26 to highlight a widening divergence between Baidu's AI infrastructure and legacy advertising businesses. Stronger-than-expected cloud demand should more than offset continued advertising weakness, allowing Baidu Core revenue to return to modest y/y growth. However, the declining contribution from high-margin advertising, combined with sustained AI investment, will continue to weigh on earnings. We raise our 3Q26 consolidated revenue estimate by 1.6% to RMB30.7bn, down 1.4% y/y, while cutting our non-GAAP operating profit estimate by 34% to RMB1.5bn. AI Cloud Infra is likely to be the standout positive, with growth approaching triple digits. We raise our 3Q26 AI Cloud Infra revenue estimate by 16% to RMB8.0bn, implying 91% y/y growth, accelerating from 50% in 2Q26, and 9% sequential growth. Demand remains robust, particularly from large internet companies, embodied AI, autonomous driving and gaming applications. GPU computing capacity remains supply-constrained, allowing Baidu to prioritize higher-quality customers and workloads. Cloud gross margins are also expected to continue improving, supported by favorable GPU economics and better customer selection. We now forecast total AI-powered business revenue to grow 36% y/y to RMB13.1bn, accounting for 53% of Baidu Core revenue, up from 50% in 2Q26. Legacy advertising remains under significant pressure, but cloud growth is increasingly sufficient to offset the decline. We maintain our forecast for Legacy Business revenue to decline 23% y/y to RMB9.7bn in 3Q26. The weak macro environment continues to constrain advertiser budgets, particularly among SMEs, while competitive pressure remains elevated. Meanwhile, Baidu continues to prioritize user experience over near-term monetization in its AI search transformation, limiting the recovery in advertising revenue. We do not anticipate a meaningful improvement in the coming quarters. Nevertheless, the incremental revenue contribution from AI Cloud Infra should more than offset the decline in Legacy Business, allowing Baidu Core revenue to increase 0.5% y/y to RMB24.8bn. Profitability remains the key near-term challenge. Despite stronger cloud revenue, the unfavorable mix shift away from high-margin advertising and continued investment in foundation models and AI applications are likely to pressure margins. We reduce our 3Q26 Baidu Core non-GAAP operating profit estimate by 35% to RMB1.45bn, implying a 5.9% margin, and lower consolidated non-GAAP operating profit to RMB1.49bn, with a 4.8% margin. Improving capital discipline provides an important offset. Despite accelerating cloud growth, we expect Baidu's 3Q26 CapEx to decline significantly from RMB11.4bn in 2Q26 to below RMB8bn, consistent with management's earlier indication that 2Q represented the peak. Full-year CapEx is expected to remain within RMB30–40bn. We view the combination of stronger cloud growth, improving cloud margins and more disciplined infrastructure spending as encouraging evidence that Baidu can scale its AI business without a proportional increase in capital intensity. Meanwhile, Kunlunxin's potential IPO remains an important valuation catalyst, although its timing is subject to regulatory progress and market conditions. Estimate revisions. We raise our 3Q26 Baidu Core revenue estimate by 2%, but cut non-GAAP operating profit by 35%. For FY26/27, we lower consolidated non-GAAP operating profit estimates by 12%/15% and non-GAAP EPADS estimates by 12%/11%, respectively. While the earnings reset warrants a lower valuation, we believe the accelerating cloud business, improving infrastructure economics and potential asset value realization continue to support an attractive long-term risk/reward profile. We maintain BUY.