Baidu drops its offer to buy out iQiyi

Criticized by its investors as a sweetheart deal for Baidu’s (NASDAQ: BIDU) chief to profit at the expense of public shareholders, the $2.3 billion bid to buy out the company’s video-streaming operation was dropped by the chief executive of Chinese search giant Baidu Inc. 

This Monday, a consortium including its CEO, Robin Li, and the CEO of video site iQiyi.com, Yu Gong, withdrew their February offer to acquire iQiyi because they couldn’t reach an agreement on the deal structure and purchase price.

The aborted bid comes after New York hedge fund Acacia Partners, which says it owns more than $400 million in Baidu shares, wrote an open letter to Mr. Li last week criticizing the low sale price of the video unit. Acacia argued that the consortium’s offer valued Baidu’s video platform at $2.8 billion compared with a $4.8 billion valuation for rival Youku Tudou, which Alibaba Group Holding Ltd. bought in 2015.

Acacia said the short-term upside to Baidu’s earnings from the sale was minimal compared with the potential long-term value for Baidu shareholders if they continued to own the video unit.

The withdrawal comes ahead of Baidu’s second-quarter earnings, due this week. Baidu has cut its revenue forecast for the quarter to $2.8 billion from $3.1 billion expected previously. Analysts surveyed by Thomson One estimate on average revenue of $2.7 billion because of a decline in medical advertising after a government investigation into the search company’s search and advertising practices.

Baidu has poured money from its lucrative search business into cash-burning operations, including online video. The company has had a near monopoly on China’s internet-search traffic since Google Inc. pulled out of China in 2010 because of censorship concerns. While investors have pushed Baidu’s management to improve profitability in its video and on-demand business, many investors considered the buyout bid a lowball offer.

iQiyi, which is China’s top online video site by subscribers, has as of June more than 20 million subscribers paying for content and is valued at $5.8 billion by Shanghai market-research firm 86Research. The firm values rival Tencent Holdings Ltd.’s video business at $7.4 billion and Youku at $4.7 billion. China’s online video advertising market is estimated to reach 53 billion yuan ($7.93 billion) by 2018, up from 16 billion yuan in 2014, according to 86Research.

Some analysts and investors had questioned the iQiyi deal shortly after it was announced. In a February research note, analysts at Arete Research Asia Ltd. said the $2.3 billion price barely covered the expenses Baidu sunk into the video unit and speculated that Mr. Li and his buying consortium might try to publicly list the company in China to get a higher valuation. When the deal was originally announced, Baidu’s shares, listed in New York, rose 7%, with investors seeing the sale as a way to clear the video unit’s losses from Baidu’s balance sheet.

“Baidu’s investments in Qiyi will be monetized by its CEO and management, and not the shareholders that funded them,” Arete analysts said.

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