July 21, 2017 / 7:41 AM / a year ago

Fitch Rates Baidu's Notes Final 'A', On Watch Negative

(The following statement was released by the rating agency) HONG KONG/SEOUL, July 21 (Fitch) Fitch Ratings has assigned China-based Baidu Inc.'s (A/Rating Watch Negative (RWN)) USD900 million 2.875% senior unsecured notes due 2022 and USD600 million 3.625% senior unsecured notes due 2027 a final rating of 'A' on RWN. The assignment of the final ratings follows the receipt of documents conforming to information already received. The final ratings are in line with the expected rating assigned on 26 June 2017. The notes are rated at the same level as Baidu's Issuer Default Rating as they constitute direct, unconditional, unsecured and general obligations of the company. The proceeds from the notes will be used for debt repayment and for general corporate purposes. The RWN will be resolved when management has provided further information on its wholly owned Financial Services Group's (FSG) expansion plans, risk control policies and procedures, and capital structure. We may affirm the ratings at their current level or downgrade the ratings, although any downgrade is likely to be a single notch. Our review will take into account Baidu's strong net cash position, which provides a cushion to fund potential losses in the FSG. KEY RATING DRIVERS Placed on Negative Watch: Fitch placed Baidu's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) and 'A' foreign-currency senior unsecured rating on RWN on 31 May 2017. The RWN reflects Fitch's belief that the rapid growth in Baidu's financial services activities under its FSG has increased Baidu's overall business risk. The risk profile of the financial services activities is significantly higher than the risk profile of Baidu's core internet services, such as search services, online video and transaction services. Elevated Business Risk: The FSG sells wealth management products (WMPs), which are mostly fixed-income products with short tenors of up to 12 months, and operates a micro-lending business. Baidu's wealth management business is similar to that of many Chinese banks and WMPs are part of the shadow banking system in China. As with Chinese banks, Baidu does not need to set aside large capital against potential defaults on its WMPs. Baidu sells WMPs to retail investors and reinvests most of the funds via a third-party trust company into money market investments, other fixed-income investments and corporate borrowers. Although we understand that Baidu is not legally bound to pay the target return on the WMPs to investors, we believe the potential damage to the company's reputation can be large. Therefore, we think Baidu may have to compensate WMP investors if the WMPs fail to achieve the target returns. We also believe the risk profile of Baidu's micro-lending business is higher than Baidu's core business, as its loans and cash credits to consumers are unsecured. Rapid Growth in WMPs: Baidu's FSG business has grown from assets of CNY12 billion at end-2016 to CNY25 billion at end-March 2017, and we expect both the FSG's WMP assets and micro-loan book to continue expanding rapidly, at least in the short term. WMPs continue to proliferate in China as there is abundant liquidity, but a scarcity of high-yielding assets in which to invest. WMPs have become an alternative form of financing for projects or investments that would not qualify for bank loans. A large exposure to WMPs may make Baidu vulnerable to asset-quality shocks, especially as loss events rise. Contingent Loss-absorption Capacity: Our review to resolve the RWN will address Baidu's capacity to absorb losses in the FSG operations to ensure that if the FSG underperformed, the additional funding required would not be a big enough drain on cash from Baidu's core operations to threaten the 'A' rating. We believe Baidu's net cash position will be increasingly important, as it will be the primary source of contingent loss-absorption capacity. At end-2016, Baidu's net cash totalled CNY23 billion, excluding payables to WMP customers of CNY7 billion, which were funds from retail investors entrusted to Baidu to invest in WMPs. DERIVATION SUMMARY Baidu's credit profile compares favourably with its internet peers, such as eBay Inc. (BBB/Stable) and Expedia, Inc. (BBB-/Stable), but is weaker than Alibaba Group Holding Limited (A+/Stable) and Tencent Holdings Limited (A+/Stable). Baidu's cash-generation ability is weaker than that of Alibaba and Tencent. Baidu's ratings benefit from its dominance in China's search engine market, but it faces challenges to diversify its business lines and revenue sources from its core search services. It has assumed higher risk in the expansion into transaction services and financial services activities, which has resulted in high gross leverage and lower profitability than Alibaba and Tencent. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue compounded annual growth rate of about 17% in 2016-2019 - Operating EBIT margin of 16%-17% in 2017-2019 - Annual capex of CNY16 billion-19 billion in 2017-2019 - No cash dividend and the USD2 billion share buyback programme to be completed by end-2017 - Net cash position to be sustained in 2017-2019 RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - Positive rating action is currently not envisaged. Developments that May, Individually or Collectively, Lead to Negative Rating Action - Fitch plans to resolve the RWN when it has further information on the FSG's expansion plans, risk control policies and procedures, and future capital structure. The final ratings will depend on Baidu's risk control of its financial services activities, the pace of the FSG's growth and the availability of loss-absorption capacity in terms of net cash position. We may affirm the ratings at their current level or downgrade the ratings, although any downgrade is likely to be a single notch. LIQUIDITY Strong Liquidity: We expect Baidu to continue to maintain a large net cash balance. At end-March 2017, Baidu had cash and short-term investments of CNY91 billion. This compared with total debt of CNY58 billion, which included redeemable non-controlling interests at subsidiaries. Mostly US Dollar Unsecured Debt: Excluding payables to WMP customers of CNY20 billion, Baidu's total debt was about CNY58 billion, with the vast majority unsecured and denominated in US dollars at end-March 2017. US dollar unsecured notes totalled USD4.75 billion and US dollar unsecured bank loans amounted to USD1.5 billion. In addition, iQiyi, a majority-owned online video subsidiary of Baidu, issued USD1.5 billion convertible notes to third parties in January 2017. Of the US dollar debt, USD750 million of 2.25% unsecured notes and USD500 million of unsecured bank loans will be due in the next few months before end-2017. Contact: Primary Analyst Kelvin Ho Director +852 2263 9940 Fitch (Hong Kong) Limited 19/F., Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Shelley Jang Director +822 3278 8370 Committee Chairperson Steve Durose Managing Director +61 2 8256 0307 Date of Relevant Rating Committee: 29 May 2017 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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