(Bloomberg) -- As China’s internet sector struggles with slower growth, Baidu Inc. faces a key test in demonstrating it can capitalize on its early-mover advantage in artificial intelligence to revive its slumping shares.

Baidu shares have dropped nearly 30% since July in Hong Kong, underperforming peers as the high costs of AI development compound investor concerns over the weak economy’s drag on advertising revenue. The company’s fourth-quarter earnings report due later Wednesday is expected to show sales growth flat compared with the previous quarter at 5.9%.

The company’s Ernie Bot was launched in September as China’s first ChatGPT-like service and amassed more than 100 million users by the end of December. But with Tencent Holdings Ltd. and Alibaba Group Holding Ltd. quickly ramping up rival services, Baidu faces a “make or break” year in 2024, according to Sanford C. Bernstein & Co. 

A revamp of the company’s apps is underway and “succeeding here is the most critical part for Baidu’s AI story,” Bernstein analyst Boris Van wrote in a note. “This is what will drive a large increase in user traffic and lead to higher ad rates as this allows Baidu to drive cost-per-sales monetization.”

The window may be closing as competitors including Alibaba’s Tongyi Qianwen and Tencent’s Hunyuan seek the same level of user traffic in order to realize profits from AI. Given its much smaller size, Baidu may have trouble keeping up with the pace of investment by these private behemoths and state-backed firms like Huawei Technologies Co.

“Baidu’s once-leading position in China’s AI sector is being rapidly eroded,” said Robert Lea, an analyst with Bloomberg Intelligence. The company’s AI operations “remain loss-making in aggregate and are unlikely to turn a profit during the next three years due to the rising competitive pressures in the sector.”

Confidence in the company’s outlook seems to have declined in the runup to the upcoming results. The average analyst price target for Baidu has slid 15% from an October high. Baidu’s shares were also hit hard in mid-January after a report linked its Ernie AI platform to key military research, spurring concerns about retaliation from Washington. Baidu denied any such affiliation but the stock hasn’t fully recovered.

To be sure, better-than-feared results could trigger a big share price bounce after the recent plunge. The options market is implying a 6.7% share movement in either direction following the results, which would be the biggest post-earnings move since the first quarter of 2022.

JPMorgan Chase & Co. expects results for the December quarter to be in line with consensus estimates, marked by “lackluster online ads revenue” as well as higher spending on investments in AI infrastructure and marketing. The stock’s performance this year will hinge on China’s macro outlook and the company’s ability to monetize its generative-AI business, analysts including Alex Yao wrote in a note.

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(Updates option market pricing in the eighth paragraph. An earlier version of this story corrected the name of the Tencent’s AI model.)

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