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Software&Services Sustained cloud momentum amidstprolonged advertising headwinds Leo Chiang,CFA Research Analyst Lowering earnings due tofoundation model investments and one-off lossesDespitebroadlyin-linerevenue,2Qadjustednetprofitmissed consensusby20%, +852-220-36240 primarily due to wider losses from FX and long-term investments. Al cloudinfrastructure revenue sustainedstrongmomentum,growing+50%YoY,drivenbyrobustAlcomputingandGPUdemand.However,thelegacyadvertisingbusinessremainedweak,declining19%YoY,attributedtoongoingbusinesstransformationand delayed monetization.Looking into 3Q,we anticipate that the strongmomentum in Al cloud infrastructure will persist,though advertising weaknessmaybemoreprolongedthaninitiallyexpected.Thecompany'splanstoincreaseinvestmentinfoundationmodelstocapturegrowingdemandareexpectedtoleadto near-term margin dilution.Overall, we have lowered our FY26/27 revenueforecastsby3%/3%andadjustednet incomeby26%/19%,resultinginarevisedDCF-basedtargetpriceof USs166.Despitetheserevisions,weremainpositiveonthecompany'sleadingposition in itsfull-stackAlcloud business,particularlyitsAlchip segment.Potential near-term catalysts include further developments in theKunlunxin IPO. We reiterate our Buy rating. Alcloud infrastructure:expectingfurtheracceleration in2HDespite a slight moderation in overall growth during 2Q due to factors such as delivery timing,demand for Al cloud infrastructure remains strong across bothtraining and inferenceworkloads.Notably,GPUcloudrevenuefurtheracceleratedsignificantlyto 283%YoY, up from 184%YoYlast quarter.Existing key clientsincreased their usage and spending,while the overall customer count rapidlyexpanded across various sizes.Demand remained broad-based across verticals,particularlystronginInternet,autonomous driving,and embodiedAl,whichalonesaw six-fold YoY growth. Management anticipates potential further growthacceleration in2H26. Ad:prolongedheadwinds continuing Despite Al transformations enhancing search quality and user experience,thecompany is deliberately holding back on Al search monetization.The near-termpriority remains product and user experience refinement, a strategy that isdragging advertising revenuein the near-term andis expected to persist into 2H26.Management believes that improved model capabilities and superior userexperiences will naturally lead to future monetization opportunities in the longterm. Software&ServicesBaidu Baidu views its foundation model capabilities as a critical component of its full- stack Al services and a significant driver for future growth. Consequently, thecompany plans to increase investment in its foundation model, Ernie, with the aimof accelerating Al iteration and restoring Ernieto a top-tier status.We believe thisinvestmentwill encompass top Altalent acquisition,R&D,and enhancedcomputing resources.While we remain positive on the long-term monetizationpotential of Al foundation models, we anticipate near-term margin dilution as aresult of this intensified investment. 2Q26 key takeawaysBaidu general business BaiduGeneralBusinessrevenuewasRMB25.2bn,down4%YoY/3%QoQ.BaiduAppMAUsreached 644mn inJune2026.TheAl-powered shareofrevenuemixeasedto50%from52%in1Q26.LegacyBusiness revenuedeclined 23%YoYtoRMB10.4bn (up3%QoQ)Onlinemarketingservicesrevenuewasdown19%YoYtoRMB13.1bn(up4%QoQ). Al-poweredbusinesses Revenuefrom BaiduCoreAl-poweredBusiness reached RMB12.5bn, up25%YoY/down8%QoQ. Al cloud infra AlCloudInfrarevenuegrew50%YoYtoRMB7.3bn,down17%QoQ.Withinthis,GPUCloudrevenueacceleratedfurtherto283%YoY,upfrom184% in the prior quarter. Combined AICloud revenue (Infra+Applications)reachedRMB9.9bn,up34%YoY.QianfanMaaS external customertokenusagegrewmorethanincludinginternet,gaming,embodiedAl,autonomousdriving,usageand spending among existing customers.On margin,management indicated that AlCloud Infraprofit and marginsboth increased YoY in 2Q26, with GPU Cloud carrying a more attractivemarginprofilethantraditionalCPUcloudandrepresentingagrowingshareof the mix.MaaS-relatedrevenuewas describedas stilla relativelysmallshare of Ai Cloud Infra revenue but an increasingly meaningful margincontributor over the longer term as usage scales and unit inference costsdecline.Kunlunxin extended its model coverage in 2Q26 to newer foundationmodels.Management outlined a product roadmap including the latestM100 optimized forlarge-scale inference and the upcoming M300 series. Software &ServicesBaidu launched an enterprise editionof DuMate in June2026.BaiduWenkuandBaidu Drive continued deepening Al integration, including GenFlowupgrades, with AI DAU penetration up 27.4%YoY in June 2026.MiaodaMAUs increased 67%versusMarch2026.Managementhighlightedgrowing user stickiness on Miaoda,noting an increasing share of usersmoving beyond one-off experimentation to iterative, ongoing appdevelopment.Famo Agent was citedas gaining early commercial tractionwith leading enterprises in 2Q26,following its 2.0 launch last quarter. Ernie Assistan