Photo credit: Jon Russell /Flickr.com

Recent news reports suggest problems ahead for Chinese search giant Baidu (Nasdaq: BIDU). The company announced its lackluster quarterly forecast last month and that was followed by increased Internet censorship by regulators in China. But first, the financials.

Baidu’s Financials

Baidu’s first quarter revenues grew 24% over the year to RMB 15.821 billion (~$2.454 billion), ahead of the market’s forecast of $2.05 billion. EPS of $0.91 was also ahead of the market’s forecast of $0.78 for the quarter.

By segment, revenues from Online Marketing Services grew 19% over the year to RMB 14.931 billion (~$2.316 billion) with active online marketing customers growing 12% to 587,000. Revenue per online marketing customer grew 7% over the year to RMB 25,400 (~$3,939). Revenues from Other Services grew 332% to RMB 0.89 billion (~$0.14 billion).

Among operating metrics, mobile search monthly active users (MAUs) grew 9% over the year to 663 million. Mobile maps MAUs grew 19% to 321 million. Gross merchandise value for transaction services grew 268% over the year to RMB 16.0 billion (~$2.5 billion) and Baidu Wallet activated accounts grew 152% to 65 million at the end of the quarter.

Baidu’s forecast, however, is concerning. For the current quarter, it expects revenues of RMB 18.1-18.2 billion (~$2.807-$2.823 billion) compared with an earlier estimate of RMB 20.11-20.58 billion (~$3.119-$3.192 billion). The Street had forecast revenues of RMB 20.08 billion (~$3.114 billion).

Baidu’s Worries

Baidu attributed the weak guidance to increased scrutiny into healthcare and related ads by regulatory authorities and the reduced number of sponsored links across Baidu’s platform. The reduced number of links will hurt advertising revenues in the short term, but Baidu believes it will lead to better user experience going forward.

Recently, Baidu was in the middle of a big controversy following the death of Wei Zexi, a 21-year-old student who was suffering from a rare cancer. Wei followed controversial treatment based on advertisements he saw on Baidu. Since his death, the Chinese authorities launched an investigation into the Internet advertising market and also levied tighter regulatory norms. According to the new norms, Chinese authorities will now require search engines to report banned content and verify advertisers’ qualifications. The new rules will be effective from August 1^st and will prohibit search engines operating in China to display banned information in various formats including links, summaries, cached pages, associative words, related searches, and relevant recommendations. Additionally, the engines will now be required to report websites and applications that contain prohibited content when spotted.

While the move is aimed at advertisers in general, it will have a significant impact on healthcare related advertising. According to a report by Tencent Technology, Baidu earned nearly $1.5 billion in advertising revenues in 2014 from hospital and medical service provider advertisements. Due to the investigation, Baidu also noted that high quality medical customers had reduced or delayed spend to be compliant with new regulations. Baidu expects spending by these firms to recover over time.

Meanwhile, to meet the new rules, Baidu will now restrict the number of sponsored posts to 30% of a results page and also establish a RMB 1 billion (~$0.15 billion) fund dedicated to fighting fraudulent representations.

The market is not too pleased with the company’s outlook. Its stock is currently trading at $161.87 with a market capitalization of $56.05 billion. It touched a 52-week high of $217.97 in November last year. It had fallen to a 52-week low of $100 in August last year.