Chinese tech companies suffer shrinking profit margins

By Bloomberg | 20 May 2019 at 08:29hrs
Queen Elsa of "Frozen" might have some advice for those Chinese technology giants nostalgic for the fairy-tale days of fast growth and fat profits: "Let it go, let it go."

Recent earnings reports from Baidu Inc., Alibaba Group Holding Co. and Tencent Holdings Ltd. show what happens when management remains desperate to keep the top line climbing. Spoiler alert: profitability plummets.

China's biggest tech companies are not only battling a sustained economic slowdown, they're getting to the natural end of a decades-long expansion – fueled by the theory that if revenue grows, profit will automatically follow.

Baidu is the biggest victim of this folly. The search-engine company was so desperate to juice sales, especially over Lunar New Year, that it doubled spending in the line item that includes marketing. That gambit failed with revenue climbing at the slowest pace in almost two years. As a result, operating margin in this core business fell a staggering 29 percentage points from a year prior to just 6%.

In a conference call on Friday, Baidu said it originally planned to boost expenses by 1 billion yuan ($144.6 million) every quarter this year, or about 6.3%. Given broader economic weakness, management said it would have to curtail those projections.

Over at Alibaba, where revenue growth has been more robust, margins also took a dive for similar reasons. Alibaba is an e-commerce company that gets most of its revenue from advertising: Revenue from this core business climbed a more-than-respectable 54%. But the price it paid was a steep cut in operating margin at the division to 27.4%, which is less than half the level it was barely two years ago.

Tencent, meanwhile, has chosen pragmatism over the blind chase for revenue. In the March quarter, management cut its sales and marketing spending by 24%, the most in four years. That helped boost operating income, despite across-the-board weakness in revenue, which grew 16.3%, the slowest pace on record. After removing the subcategory called other gains, which includes those from investments, the company reported its highest operating margin in a year. As a result, Tencent was the only company of the three to post a rise in operating profit, climbing 11% to a new record.

If Baidu, a 19-year-old Internet giant, is still struggling to get people to download its apps, there's a problem. Alibaba and Baidu both suffer from the mistaken belief that spending money now, in the thick of an economic slowdown, will guarantee future revenue.

For more than a decade, tech company executives focused solely on boosting revenue as global investors fell in love with China's emerging middle class. As Elsa sings, "That perfect girl is gone."



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