Baidu (NASDAQ: BIDU) unveiled Kunlun, its artificial intelligence (AI) chip optimized for cloud-to-edge computing tasks, three years ago. At the time, he claimed that the 14nm chip provided 1.5 to three times more processing power than NVIDIAComparable T4 GPU for AI tasks.

Baidu began mass-producing Kunlun chips through its eponymous subsidiary in 2020, and it had installed nearly 20,000 of these chips to power its search engine and other applications as of September. It also revealed the Kunlun 2, a 7nm chip that could offer three times the processing power of its predecessor, and its intention to mass-produce the new chips in the second half of 2021.

In March, Baidu finalized a funding round for Kunlun, led by CITIC Private Equity Funds Management, which valued the chipmaker at $ 2 billion. Other investors included IDG Capital, Legend Capital and Oriza Hua. Baidu still held a 76% stake in Kunlun after these investments.

Image source: Baidu.

However, Baidu recently split Kunlun as an independent company with a valuation of around $ 2 billion. Ouyang Jian, the chief chip architect, will be the CEO, and the stand-alone chipmaker could raise more funds on its own, enter into new partnerships and expand into new directions.

Let’s take a look at why Baidu separated its AI chipmaker, how the move ties into the US-China tech war, and what it all means for investors.

Why did Baidu split from Kunlun?

To understand why Baidu split from Kunlun, we need to understand how he makes money. Baidu generated 68% of its revenue from its online marketing services in fiscal 2020. The remainder came mainly from its streaming video subsidiary. iQiyi (NASDAQ: IQ) and its cloud infrastructure platform.

Baidu’s online marketing business has been rocked by macro headwinds, tighter regulations for ads, the pandemic, and competition from monolithic apps like Tencent‘s WeChat for the past two years. However, its online marketing unit still generates higher margin revenue than iQiyi, which remains unprofitable more than a decade after its initial launch. Baidu Cloud is also probably unprofitable because Ali Baba The cloud still fails to generate stable profits despite being the dominant market leader.

As Baidu’s advertising business plummeted, it relied more on iQiyi and Baidu Cloud’s low-margin revenue to drive revenue growth. This strategy was not sustainable and Baidu reportedly tried to sell iQiyi to Tencent and Alibaba last year after its growth stopped.

Baidu’s online marketing revenue finally grew for the first time in eight quarters in the first quarter of 2021. It expects that growth to continue into the second quarter, so that its highest-margin business will finally stabilizes again.

Therefore, now is the perfect time for Baidu to streamline the rest of its portfolio by divesting more of its low-margin, non-core businesses. Kunlun, a capital-intensive chipmaker trying to challenge established market leaders like NVIDIA, clearly ticks both boxes.

How does Kunlun relate to technological warfare?

The technology war between the United States and China – which has escalated dramatically under the Trump administration – revolves around China’s dependence on American technology. The United States wants to cut China off of the world’s most advanced chips, while China is increasing production of its own local chips to reduce its dependence on foreign companies.

Chess pieces placed atop the Chinese and American flags.

Image source: Getty Images.

At the center of this conflict is the “process race” to create smaller, more powerful chips. These chips are measured in nanometers; the world’s most advanced chips measure from 5nm to 7nm.

Semiconductor manufacturing in Taiwan (NYSE: TSM) and Samsung, the world’s most advanced chip foundries, manufacture most of the world’s 5nm to 7nm chips. Minimum wage, China’s most advanced chip foundry, still cannot mass-produce chips beyond the 14nm node.

Samsung’s foundry made the first generation of Kunlun’s AI chips, and it will likely manufacture the second generation chip later this year as well. TSMC, which is cut off from Chinese chipmakers by US blacklists and sanctions, is a much less likely candidate.

But in the longer term, Samsung could also face pressure to reduce or suspend production of chips for Chinese chipmakers. On that day, Kunlun may have to look to SMIC – which remains generations behind TSMC and Samsung – to continue making chips.

Baidu probably doesn’t want to face this dilemma in the future, so he part ways with Kunlun before he gets too involved in his main business.

What does the spin-off mean for investors?

The Kunlun split was the right move for Baidu. It doesn’t need another capital-intensive business on its balance sheet, and the chipmaker might do better as a stand-alone business.

Taking a step back from Kunlun could also allow Baidu to expand its higher margin software business – including Smart Mini programs on its mobile app, the DuerOS virtual assistant, and the Apollo platform for driverless cars. – instead of getting bogged down in the difficult semiconductor market. .

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.