Alicia Yap

Baidu revenue dropped for the 3rd consecutive quarter, and the stock has sold off. However, the company holds ~$42 billion in net cash and liquid assets. The market is valuing the legacy search business at near zero. The current valuation ignores the cash pile and the potential value unlock from spinning off its AI chip unit (Kunlun) and cloud business. LONG (Deep Value Play). Continued erosion of the core advertising business by competitors like Tencent and ByteDance could make the "value trap" argument persist.

Despite the massive AI capex spending causing a one-quarter negative free cash flow, Tencent's core business is still generating decent operating cash flow. The spending is front-loaded to secure procurement, and new revenue streams like Yuanbao (Work Buddy) are already materializing.

Tencent, ByteDance, and Alibaba will ultimately emerge as long-term winners in the AI sector, but there is no real visibility on the payback for their significant investments, which will act as a margin headwind and depress free cash flow for at least the next 18 months.

Investors should rotate back into China big tech names like Tencent, Alibaba, and Baidu because their valuations and fundamentals matter, whereas AI pure plays are highly volatile and need more time to demonstrate they can deliver.

Tencent is attractively valued when excluding its investment portfolio and cash. Despite debates about its AI strategy, the underlying valuation is compelling. Citi has a buy recommendation.