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If you've been keeping an eye on the market, you may have noticed that Baidu (BIDU) experienced a 7% drop in its U.S. stock and an 11% decline in its Hong Kong stock on Friday. This abrupt shift was triggered by a report from the South China Morning Post (SCMP), citing an academic paper from a university affiliated with the People’s Liberation Army cyber warfare division.

It's not uncommon for investors to react swiftly to information that could impact a company's reputation or operations. Particularly noteworthy is that this information touches on an extremely sensitive topic: the China-US relationship. However, it's essential to delve deeper, examining what it says in the source (which is the research paper) and the company's response, as short-term fluctuations may not accurately reflect the long-term prospects of a fundamentally strong company like Baidu.

Following the accusation, Baidu quickly responded to recent media reports in a press release published today, clarifying that it is available to the general public and has not been part of any business collaboration or provided tailored services to the authors of the academic paper or affiliated institutions. Most importantly, the South China Morning Post, the first media outlet reporting on the academic paper, has issued clarifications and corrections to their original report. The correction states that the PLA lab tested its system on the Baidu model, but corrected its initial reporting that there was a physical link between its AI system and Baidu’s Ernie.

TL;DR: Baidu's recent stock dip seems like an overreaction, providing a favorable buying opportunity with the company's strong PR response. The market is expected to correct soon. Notably, investment bank Daiwa concurs, stating that Baidu's selloff due to the SCMP article is overdone.

Take a closer look at this research paper

I have closely examined this paper. The paper is authored by PLA researchers aiming to build a Large Language Model (LLM) for predicting war field situations. In this document, the researchers listed several Large Language Models ("LLM"), including GPT3.5, GPT-3.5-turbo, GPT4, and HTML-T5. However, they used Baidu's ERNIE Bot as an example to generate answers to validate their argument. It's important to note that this doesn't imply a direct relationship between Baidu and the PLA. Just like anyone can use ChatGPT or Bard, anyone can use ERNIE Bot. If the PLA were to use ChatGPT for their research, would that mean they are collaborating with OpenAI or Microsoft?

Also more importantly, the paper asserts that ERNIE Bot's answers are general and unusable. My feeling is ERNIE Bot's answers are no better than a military enthusiast’s commentary, which reinforces the idea that the utilization of ERNIE Bot in the report is more illustrative than indicative of any specific collaboration between Baidu and PLA.

Opportunities and Risks:

Despite recent market fluctuations, Baidu's robust fundamentals remain a key driver of its long-term value. The company has showcased resilience and innovation across various sectors, encompassing search engines, artificial intelligence, autonomous driving, and cloud services. Investors may find Baidu particularly appealing due to its low and attractive Price-to-Earnings (PE) ratio, especially when compared to other tech companies. Jefferies has identified Baidu and Alibaba as companies with significant hidden value, attributable to their substantial excess cash holdings.

Certainly, it's crucial to acknowledge and assess the associated risks, especially in the current geopolitical climate where political factors can influence market dynamics. Political risks are inherent for all Asian companies, and navigating these uncertainties is an integral part of investment strategy.

However, within China, there are a multitude of companies actively engaged in the domain of Large Language Models. The probability of the People's Liberation Army (PLA) singling out a particular tech company's Language Model as a preferred model is exceedingly low. Additionally, there is the consideration that the PLA may opt to keep information private and develop its own Large Language Model.

What’s next?

My short-term perspective aligns with the notion that the ongoing narrative might keep the story in the spotlight, potentially causing a dip in the stock price below $105 or $100. This, however, could present an opportune entry point for investors, as the market often has a tendency to overreact to short-term events. Investors with a long-term perspective may find this period of volatility as an advantageous buying opportunity, considering the eventual resilience and growth potential of a company like Baidu.

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