Is the honeymoon period over for consumers? The spring of advertising can't be stopped.

Hello everyone, I am Dolphin Analyst!

The third quarter ended with a mix of joy and anxiety. Chinese concept stocks, which were originally expected to follow the fate of the US stock market and raise interest rates, suddenly received a big gift with three surprises, bringing a heart-stirring rebound.

The first surprise came when Reopen arrived earlier than expected, and the border was opened without waiting until the second half of the year.

The second surprise was that the Internet platform economy once again received positive feedback from regulatory authorities, indicating that the new year would gradually move away from the strong regulatory era and move towards normalized positive regulation.

The third surprise was that the greatest risk of Chinese concept stock audit inspections has now been addressed, and the risk of Chinese concept stock delisting has been basically eliminated.

Although after the reopening, due to the climb of the infection rate in the short term, there will inevitably be a "darkest" consumer environment that looks more severe than expected at the beginning of the year, the direction and timing of the recovery are now more clear. In every round of economic cycles, merchants are the first to sound the drumbeat of recovery, and a large number of advertisements will appear before consumer confidence is restored.

This article will focus on advertising. At the beginning of the year, we talked about the need for advertising stocks to find a safe margin of certainty in an uncertain economic environment. However, as we stand at the turning point of recovery now, we tend to focus more on platforms with higher performance repair elasticity in the advertising industry, which is often difficult to surpass in the long term in the macro economy. The targets covered in this article are mainly pure advertising stocks, Baidu. US and Focus Media. SZ.

I. Starting point of recovery, advertising leads the way

Advertising is the barometer of the macro economy, and the merchant's advertising budget is based on the expected consumption for a period in the future. This is also the logic that Dolphin Analyst has repeatedly explained in the article "The Darkest Advertising: It's Enough Without Valuation Knowledge", which is the "essence" of advertising: In the long term, it is difficult for a mature advertising industry to achieve growth rates exceeding GDP, but in the short term, there will be "offensive" or "retreat" runs at different turning points in the economic cycle.

Compared with the United States, China's advertising industry is not yet mature. From the perspective of brand marketing, Chinese merchants' budget allocation for brand building is still not enough. Although China's advertising still has such a "hidden growth space" compared to US advertising, in the past ten years, the overall advertising market has basically followed the fluctuations of GDP. If compared with more direct consumption indicators, during the period of 2013-2016, the growth rate of advertising even lagged behind the social zero.

In the medium and long term, we see that the growth rate of advertising is highly synchronized with GDP growth rate. Only by further paying attention to the turning points of each cycle can we see the phenomenon of "detachment" between advertising and the economy-in the face of environmental factors that have a greater impact on the economy, businesses will quickly shrink their budgets. And when the economy is expected to recover well, they can quickly make the decision to expand their budgets.

This has caused short-term fluctuations in advertising growth rate to be much higher than that of economic growth rate in times of economic uncertainty. In addition, in recent years, the popularization of online intelligent delivery systems and the convenience of options such as shorter delivery cycles and specific location selection have made it easier for businesses to stop and restart their advertising.

Compared to advertising, macroeconomic reactions are relatively slow, especially in the upstream production end. Therefore, during times of economic volatility, advertising will show a more sensitive curve of change.

Take the situation under the epidemic in the past two years as an example. The characteristics of advertising that depend on the macro but are more sensitive can be better reflected when economic uncertainty is extremely high: in 4Q20 and 2Q22, which are the periods of recovery after early epidemic control and large-scale blockade in first-tier cities, respectively, the changes in the growth rates of advertising and social retail are quite different.

In addition to the larger amplitude of action, because advertising delivery focuses on future income expectations, the actions of advertisers are faster than actual changes in consumer confidence, meaning that advertising had already rebounded one step ahead of time when consumer confidence had not yet recovered in the third quarter. This is more evident in internet advertising, and also due to the characteristics of intelligent delivery for internet advertising. Therefore, in an environment of high uncertainty in the economy, advertisers will have shorter delivery cycles and higher frequencies.

Therefore, when we stand at the starting point of economic recovery, although we will experience a peak period of infection for 3-6 months, the direction and timing of the recovery are more clear than before. It is expected that the marketing willingness of advertisers will recover faster and more significantly than consumer confidence, and it can also be reflected earliest in the performance of advertising companies.

Next, let's discuss who has higher elasticity in the scene after deduction.

As we mentioned earlier, the demand of businesses has resulted in the high sensitivity of advertising industry's income to the macro economy, but the Alpha attributes of different platforms and different areas are vastly different. Even the growth direction can be opposite in different economic cycles due to the different conversion goals that businesses pursue in different scenarios. This will be even more apparent in stock markets that have repeated ups and downs. For example:

(1) In the early effective epidemic prevention and control period from the fourth quarter of 2020 to the first half of 2021, the overall expectation of merchants for economic recovery was generally positive, so the enthusiasm for marketing investment was relatively high, and traditional media dominated by brand marketing also achieved decent recovery, with ladder media with scarce traffic being the main one.

Therefore, although there is still an epidemic in 2021 and there are periodic restrictions in various places, Focus Media's total revenue in the whole year of 2021 exceeded the pre-epidemic level, especially ladder media advertisements that were less affected by the supply side. It significantly exceeded the previous high point (2018) before the epidemic.

(2) In the highly uncertain economic environment in 2022, in addition to being budget-conscious and relying more on performance-based advertising, due to the repeated epidemic controls in various places, under the pressure of clearing inventory, merchants will naturally tend to advertise on e-commerce platforms that are closer to the transaction and easier to convert sales. Therefore, in the overall too tragic situation of the advertising industry this year, the overall advertising revenue of e-commerce platforms still maintained positive growth.

This just confirms the judgment made by Dolphin Analyst in the advertising overview "The Darkest Advertising: Falling Too Tragically, Enough Without the Valuation Common Sense" in early 2022:

Apart from short videos with time length growth advantage, and live broadcasts as new e-commerce transaction scenes that can meet merchants' demand for GMV under economic uncertainty, other advertising channels are more looking for safety margins under pessimistic expectations.

Standing at the turning point of economic recovery in early 2023, companies with relatively high performance margin improvement elasticity should be optimally selected, and they should be able to rely on their own platform characteristics to obtain stable cash flow in normal operations. Among them, advertising platforms directly affected by epidemic control are the first to bear the brunt.

PS: Because e-commerce platform advertising is more transactional, this article focuses on the online and offline advertising market outside e-commerce advertising. E-commerce advertising will be analyzed in detail in the subsequent "E-commerce Overview".

Let's imagine the scene after economic recovery:

If we pull the timeline back to the end of 2020, which is also the turning point where merchants have good expectations, although the reasons behind it are different, the marketing decision-making ideas of merchants can be replicated.

1. First, offline advertising quickly rebounded with the return of traffic. From January to April 2021, the overall growth rate of offline advertising reached 31.4%, and from the perspective of recovery, it was higher than the same period in 2019.

Therefore, after passing the peak of the infection, it can be expected that the "excess" recovery of offline advertising will occur in 2023. Dolphin Analyst is optimistic, with an estimate that the overall market size is expected to exceed that of 2020.

2. Only scarce offline media is valuable. As the Internet continues to penetrate, from the trend of developed market in the United States, digital advertising has the advantage of accurate cross-time and cross-space marketing, and still has the power to further squeeze the share of offline media.

Therefore, it is certain that the overall market share of offline media will gradually shrink, only with differences in speed. However, the only way for different offline media to resist the trend of going online is to have channels that have independent and scarce traffic compared to online media.

Television, magazines, and traditional outdoor advertising will continue to face traffic migration. However, elevators and cinema advertising will still have certain barriers due to the "user must pass" and "low interference" characteristics. Compared with elevator manufacturers, cinema has more stable traffic, but its flow will be affected by film supply and competition from other offline entertainment, with relatively low frequency of exposure during the low season of films.

Therefore, although the overall offline advertising will see a significant restoration next year, it does not mean that it will flourish. Elevator media is still the first choice for brand promotion, which also means that it will further erode the original share of other offline media advertising.

3. Online brand promotion is expected to significantly recover, but efficiency is still a constant law. With expectations of economic recovery, merchants will distribute more marketing budgets to brand promotion, and online platforms, which originally had a high proportion of brand advertising, are expected to see significant restoration.

However, what cannot be avoided is that the time black hole created by the epidemic + short videos has overdrafted the overall industry's traffic growth for the next few years to some extent, and the anxiety of major Internet giants about growth will also continue to tighten their competition.

The comparison of advertising conversion efficiency between platforms will not ease with the expectation of economic recovery. In addition to secretly competing for new traffic, the business value behind the traffic also affects the budget of merchants. （1）After the popularization of short video function, return to the whole network to collect increment

This kind of thinking of "finding increment" is also one of the key points for merchants to screen online channels after economic recovery. From the beginning of the year to now, the flow pattern of the Internet platform has also undergone significant changes.

Generally speaking, short video is no longer just the traffic code belonging to Douyin and Kuaishou. After all platforms have launched short video functions, it seems to return to the competition for higher operation efficiency and the ability to attract fresh traffic relying on the platform itself.

According to the data from Questmobile (the top 100 app with the longest usage time), Dolphin Analyst estimated the time share of the ecosystem of various Internet giants, mainly looking at the flow changes since this year from the perspective of finding increment.

Overall, from the perspective of finding increment, ByteDance and WeChat should be the first choice for merchants. Bilibili and Little Red Book, two rapidly growing vertical categories, are also expected to receive additional budget allocation from some advertisers.

1. The most stable growth is still the ByteDance system, and its share has increased from 23% at the beginning of the year to 25.4%.

2. Kuaishou, also a short video platform, has fluctuated the most, and its time share was actually at the highest peak at the beginning of the year.

3. Tencent started to show signs of counterattack since the third quarter, corresponding to the accelerated promotion of Video Account. The total usage time of WeChat has maintained rapid growth since June. In addition, as the epidemic intensified in the fourth quarter, Tencent Meeting usage time soared. Traditional social and traditional media channels headed by QQ and Tencent News, "because they do not have hardcore functions themselves", are basically submerged in the wave of short video.

1. The total usage time share of other giant ecosystems such as Baidu and Alibaba has basically remained stable this year, with irregular small fluctuations, because they still have their own basic market.

2. Among emerging vertical channels, the time share of Bilibili, Little Red Book is still growing, and Zhihu barely returned to its peak in previous years, but the ceiling is visible to the naked eye, and it is difficult to break through.

1. Generally speaking, the total usage time has been growing since the third quarter, and WeChat of Tencent and Douyin Lite of ByteDance are the main driving forces.

(2) Your traffic and my traffic seem to be different

In this year where merchants' advertising budgets are significantly shrinking, the revenue performance of some platforms does not match their high-growth traffic, such as when there is a significant growth in traffic, the advertising revenue instead slows down significantly. This is because, in the formula for key drivers of advertising, besides the quantity factor, there is also the influence of the price eCPM.

Generally speaking, eCPM reflects the competitiveness and commercial value of a platform. From the perspective of merchants, different platforms will have different traffic values, and the logic behind it is that the purchase conversion among users has significant differences.

Currently, the difference between eCPM of major Internet platforms is significant, among which Bilibili and Kuaishou with the fastest traffic growth do not have the advantage in quotation. The reason behind it is still the purchasing power of users:

1. Kuaishou has the most direct competitor TikTok, and compared with TikTok, Kuaishou's users are more inclined to downward, and their implicit purchasing power is lower than that of TikTok.

2. The total number of users of Bilibili is not high, and the overall age is younger, mostly students with limited budgets. At the same time, the culture of "free riders" is prevalent, which is not friendly to merchants, and the budget investment is relatively limited in terms of conversion.

Therefore, for many merchants, Kuaishou and Bilibili will be considered as channels for infiltrating new users, but not as the main investment platform.

On the other hand, no matter how miserable this year is, for non-main investment platforms, the expectations for next year will only be more positive. In the case of a good economy and sufficient business budget, there will be more additional budgets allocated to high-growth verticals outside the main investment platform. And in order to obtain sustainable and stable income, the platform still needs to have certain characteristics or scarcity.

III. Industry cycles of advertisers: food is stable, the Internet hits the bottom, and offline services rebound

The above analysis mainly considers the changes in advertising investment from the perspective of merchants' general needs, but merchants in different subdivided fields also have their own industry or product cycles, so there are significant differences in the direction of budget changes.

According to CTR data, in the past two years, the only industries that maintained positive growth are mainly food, beverages, and medicines. The largest decline is in IT products and services, mainly including consumer electronics, Internet industries such as mobile phones.

The decline in consumer electronics is related to the industry cycle. Without new disruptive technological changes, it is difficult for the 3C electronics industry to maintain high growth.

As for the Internet industry, apart from the high penetration rate of mobile Internet, its own growth momentum has slowed down. Since the second half of 2021, supervision has had a greater impact on the industry.

However, everything has its cycle, and past performances are only used to summarize industry laws. Dolphin Analyst is still more concerned about the advertising industry categories with higher repair elasticity after the release of the epidemic. From the perspective of the categories most damaged and the reasons for damage in the past two years, business services, transportation, and Internet, entertainment advertising have stronger growth momentum. 1. Internet company's efficiency gains come to an end, expected to resume investment with relaxed regulations

Compared to the Internet industry, the marketing budget for the daily food and beverage industry is more resilient and stable, especially during economic downturns, where advertisements for daily necessities are stronger. For example, in the industry categorization advertisements of Focus Media, in recent years, the advertising for daily necessities has overall maintained steady growth, while the periodic fluctuations of internet and entertainment advertisements are more severe.

From another perspective, at the current point in time, the Dolphin Analyst has also noticed that the advertising growth rates for the Internet and entertainment industries are approaching the bottom:

On the one hand, Internet and entertainment companies have been lowering costs and increasing efficiency for a year now, and with marketing expenses being reduced significantly, many companies have already lowered their sales expense to pre-pandemic levels, with expense ratios continuously challenging new lows.

On the other hand, with regulation gradually returning to normalcy, traffic anxiety and growth will once again become the focus of attention for companies, which will force them to resume investment in new businesses as well as consolidate old ones.

Thus, from the perspective of Focus Media, the short term will not only benefit from the industry's recovery and performance recovery, but will also benefit from the resumption of Internet marketing investment, bringing higher elasticity.

2. Offline activities resume, local commercial services and travel advertising demand increases

Another factor is that local commercial services, and travel and tourism industries that have been significantly affected because of the pandemic, will experience significant growth in marketing investment during the initial stages of relaxation.

For example, in the United States, after some states lifted relatively strict lockdowns last year, until the complete relaxation in March of this year, the demand for wine and travel has remained strong for over a year. Therefore, even though they are facing inflation, Google, with close to 15% of its advertising revenue from travel and leisure, is more resilient in its business performance than other advertising peers.

Similarly, in China, Baidu, which has a high proportion of advertising revenue from tourism, medical and beauty, and local services, and the main marketing channels, Focus Media and Newcomer's Elevator Posters, are expected to see a relatively significant performance recovery.

3. Advertising stocks have already risen, high elasticity in performance can perfectly digest it Different economic cycles have different focal points for the advertising industry. In the beginning of the year, Dolphin Analyst emphasized the certainty safety margin under uncertain expectations in "The Darkest Advertising: Falling too miserably is enough without valuation knowledge". However, at the current inflection point of recovery, we suggest focusing on the performance elasticity of advertising companies, especially the valuations that are neutral to optimistic interpretation. Sell in the market's rebound sentiment or wait for safer volatility opportunities.

Let's summarize the analysis in sections 1-3 under the expectation of economic recovery:

1. Advertising has higher elasticity and faster responses before actual economic recovery.
2. Retailers will continuously allocate budgets into brand promotion, making it more significant for brand advertising repair.
3. Offline billboard advertising is the preferred method and will continue to eat into the share of other offline media; online advertising still focuses on efficiency, but channels with high traffic growth are expected to achieve higher revenue growth.
4. Internet and entertainment advertisements are expected to quickly hit rock bottom and recover, while offline tourism, local business services, medical beauty, and other advertisements with high revenue proportions will experience significant performance rebounds.

During the last economic downturn, the advertising revenue of e-commerce platforms showed resilience when the industry was impacted. Except for short video platforms with high traffic growth, no other industry players were able to outperform.

At the current economic recovery inflection point, Dolphin Analyst believes that from an elasticity perspective, offline billboard advertising (e.g. Focus Media), social platforms (e.g. Tencent, Bilibili, Kuaishou, etc.), search engines (e.g. Baidu), and entertainment/vertical channels (e.g. Xinyong) with scarce resources will experience significant recovery and will continue to grow quickly in the short term.

Note: As most social platforms have business models beyond advertising, Dolphin Analyst will discuss Tencent, Bilibili, Kuaishou, and Xinyong in detail in the next "Overview of the Entertainment Sector". This section mainly updates on Baidu and Focus Media.

1. Focus Media & Baidu: Be cautious in the rebound led by optimistic sentiment.

2. Focus Media: Dolphin Analyst recently wrote a deep dive into the company in "Focus Media: The Daredevil Turning the Tide". Due to epidemic adjustments and offline activity openings, Focus Media's performance has been impacted the most, which is self-evident. However, due to its unique business model, relatively fixed cost expenditures can bring higher marginal elasticity to Focus Media located at different economic turning points, with exaggerated profit growth in the short term. For a detailed analysis, please refer to Dolphin Analyst's deep dive on Focus Media in "Is Focus Media a Gold Mine or a Trap?" Compared to previous predictions, Dolphin Analyst has mainly revised the expectations for the short term in 2022 and 2023. The outbreak of the epidemic in the third quarter has exceeded our expectations in the second quarter in terms of the range of spread and the impact on the economy. And although the anti-epidemic adjustments in December were greatly advanced in time, the short-term will also further weaken the motivation for residents to resume travel and economic activities due to the surge in infection rates. Therefore, we will see further decline in short-term consumption and the economy.

But the deeper the decline, the higher the jump afterwards. We expect that in the second half of 2023, the advertising sector will follow the macro-economy and usher in a more significant recovery than previously expected. Although the first half of the year may still experience a period of sluggishness, the base period is not high because overall, it is expected to show a trend of worsening slowdown.

Based on the above assumptions and adjustments, Dolphin Analyst estimates a DCF valuation for Focus Media at CNY 93.5 billion, corresponding to a net profit of CNY 4.7 billion in 2023 at a 19x PE ratio, assuming WACC=11.16% and g=3%. In terms of historical valuation range, when the market sentiment is optimistic, the forward PE may also have the potential to soar to 25x, which corresponds to a market value of CNY 123 billion.

2. Baidu: The solid cash balance and the profit support of search advertising are the bottom-line values for Baidu. However, the intelligent car business that has been continuously invested in has also continuously consumed cash flow.

When using DCF valuation, the market actually implies a punitive expectation that innovative businesses such as Baidu's investment in intelligent cars will make a negative contribution to cash flow in the long term. According to the normal operational thinking of enterprises, when a business is expected to be unable to bring positive returns within an acceptable period, it will stop investment instead of allowing cash flow to be perpetually eroded.

Therefore, using DCF valuation for Baidu is too harsh. We prefer to use SOTP to value Baidu.

As of December 20, 2022, Baidu's market value has rebounded significantly by 50%. However, the current market has not priced Baidu at a market value of less than USD 37.5 billion. Dolphin Analyst believes that there is still an inherent bias towards Baidu's advertising position rapidly declining as well as All in AI and self-driving causing profit erosion.

Excluding the net cash balance at the end of the third quarter of 2022 (= cash + short-term investments - long and short-term interest-bearing liabilities - minority shareholders' equity, and given a 90% discount), the remaining cash balance is $24.6 billion. Assuming that the incremental value brought by Baidu Cloud, Apollo, and car-making businesses in the future is not considered, Dolphin Analyst estimates that the after-tax operating profit of Baidu's core advertising (excluding iQiyi) in 2023 is CNY 23.3 billion, with only a 7x PE ratio, which is lower than the valuation multiple of 10-12x under normal neutral expectations. Although economic activity is expected to recover significantly in the second half of next year, the Dolphin Analyst found that the market's expectation for the growth rate of Baidu's core advertising in 2023 is not optimistic (~yoy 5%), slightly lower than our expectation (~yoy 8%, compared to the recovery magnitude of 2021 relative to 2020).

The Dolphin Analyst's relatively optimistic outlook is due to:

(1) In offline consumption, advertising categories such as travel, medical beauty, and local business services will receive a significant recovery during the downward trend of new infections. Although the actual consumption boom may not occur until the second half of the year, business advertising marketing often starts early. This is also the repairing logic of Baidu search advertising.

(2) E-commerce advertising, including direct e-commerce, will be the future growth driver of Baidu advertising. As a top ecosystem with nearly 650 million monthly users and 250 million daily users, after the interconnection of internet ecosystems, Baidu has clearly gained more dividends. The trend of micro-incremental growth has accelerated since the second half of last year. Although every ecosystem is striving to do searches, Baidu is still one of the best due to its search awareness from the PC era. Therefore, from the perspective of search habits, Baidu's traffic entrance can also be said to have a certain scarcity.

In the wave of accelerated penetration of e-commerce, Baidu has launched e-commerce marketing solutions based on its own traffic scene. It is expected to become a new driving force for the growth of Baidu advertising in the short to medium term by leveraging the trend of retail online:

1. In addition to the inventory of picture and text, video, information flow ads, which are more common in other ecosystems

2. Baidu's focus characteristic is the knowledge content marketing, including Baidu Encyclopedia and Baidu Knows, as well as the first advertising banner of the homepage and the third-party e-commerce drainage in the shopping channel created around Baidu's advantageous traffic entrance

3. In addition, the continually improved self-operated e-commerce (Du Xiaodian) advertising in the past two years has been sold externally through landing pages. Currently, self-operated e-commerce advertising accounts for 10% of Baidu's entire e-commerce advertising, and the company expects this proportion to further increase.

Therefore, under the conservative valuation idea that only considers the core advertising main business and net cash, if we give a PE of 8 times to the core advertising, Dolphin Analyst calculates Baidu's conservative market value at around 37 billion US dollars, which is similar to the current price. However, at the turning point of performance expectations rebounding, we are more inclined to give a PE valuation multiple for advertising business that is neutral or slightly positive, that is, 10x, so as to demonstrate the market's expectation of improvement in sentiment as performance emerges from the trough.

In addition, for the cloud business that is currently unprofitable but has already made a substantial contribution to revenue (Dolphin Analyst estimates that the revenue share of Smart Cloud has exceeded 20%), we use a PS ( ~5x) valuation and include it in the neutral expectations of the market when it returns to normal sentiment.

As for the Apollo Autonomous Driving Program and Jidu Auto, which are further away from profitability, since they have not yet contributed much revenue, Dolphin Analyst uses the latest valuation in the primary market financing or the recent valuation of similar peers in the IPO market. In the 3Q22 earnings call, management revealed that there is currently a cumulative RMB 11.4 billion in-hand orders for the Apollo Car Intelligence Program, which is expected to begin recognizing revenue in the second half of 2023, with significant revenue recognition in 2024. Therefore, based on Dolphin Analyst's expected performance for 2023 as the basis for SOTP valuation, we view Apollo and the automotive business as upward options for optimistic sentiment.

Therefore, the current market value of Baidu traded in the market is just in line with Dolphin Analyst's relatively conservative valuation expectations. It is more suitable to look for Baidu's safety margin earlier this year, but at this point in time, we may be more positive about providing a neutral value interpretation.

Dolphin Research: "Advertising Review" Historical Articles

May 7, 2022, "The Darkest Advertising: Fall Too Disastrous, Don't Need to Know Valuation Common Sense"

January 6, 2021, "Internet Advertising Outlook: Clarifying the "True" and "False" of the 2021 Performance Revival"

Dolphin Research: Baidu 3Q22 Earnings Call

November 22, 2022, phone call, "Baidu: Lift Ads Unlocks Recovery, AI Will Continue High Investment (Summary)" 2022 Nov 22 Financial Report Review "Baidu: Valuation is all about 'cash,' what is the market afraid of?"

Dolphin Research "Focus Media" 3Q22 Financial Report Season

2022 Oct 31 Financial Report Review "Focus Media: Experienced the darkest hour, but cannot escape the cycle of destiny"

Aug 17, 2022 Conference Call "Consumer Products are Resilient, Good Cost Control is Waiting for Real Recovery (Focus Media 1H22 Conference Call Summary)"

Other historical articles on "Baidu" and "Focus Media" can be searched for in the Longbridge app community - Dolphin Research column collection.

Risk Disclosure and Statement of this Article: Dolphin Research Disclaimer and General Disclosure