IQiyi Stock Is a Play on China’s Millennial Craze
When iQiyi stock (NASDAQ:IQ) went public in March 2018, Karen Chan of Jefferies called IQ “the Netflix of China.” Her target was $33. The price of IQ stock today is $17.21. So what went wrong?
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First, competition has intensified for IQ, 56.7% owned by Baidu (NASDAQ:BIDU). IQ recently crossed over 100 million paying subscribers. Tencent Video, a subsidiary of Tencent Holdings (OTMKTS:TCEHY), is in a two-way race for first in the “red-hot” online Chinese video market, according to the South China Morning Post.
Alibaba Group Holding (NYSE:BABA) runs Youku Tudou, which holds third place. These competitors are not public, so IQ stock is the only way to play the Chinese millennials’ online video craze.
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Second, IQ’s ad revenue, 31% of its total, will stay weak this year, according to management in their Q1 conference call. China’s slowing economy is the main culprit.
Third, content cost has skyrocketed. It represented 79% of revenue in Q1, up 38% year over year. That leaves no room profits to be made after all other costs.
The reason: iQiyi, just like Netflix (NASDAQ:NFLX) produces its own for-pay drama series and variety shows as well as buys outside content. IQ believes that having unique content drives subscription growth. IQ told CNBC in May that it intends to get bigger into making movies.
IQ is really a mix between YouTube, Twitch and Netflix. Its app, which offers videos, gaming and online Twitch-like streaming, is ranked eighth in China with over 530 million monthly active users. IQ wants to take advantage of Chinese millennials’ movie and gaming craze.
To do this, IQ’s CFO told CNBC, IQ offers free content supported by ad revenue, along with pay content, especially movies and gaming. IQ calls this model “Netflix Plus.” IQ’s gaming app revenue was up 143% in Q1 after it recently acquired Skymoons.
Is IQ Valued Like Netlfix?
NFLX has over 151 million global paid members and its market value is $135.3 billion. IQ has over 100 million subscribers and its market value is $12.5 billion. This is somewhat skewed since subscriptions account for just 51% of IQ’s total sales.
Therefore NFLX’s value is $0.90 per subscriber. IQ should be valued at $46 billion on a like-for-like basis with NFLX (51% x 100 million x $0.90). But IQ’s market value is only $12.5 billion.
Why Not?
IQ went public at $18 in March 2018, giving it an $11.6 billion valuation. IQ had 50.8 million subscribers at that time. IQiyi stock rocketed to $44, giving it $28.4 billion valuation. Now iQiyi is at $17.21, up from a low of $14.35. Its valuation is only $12.5 billion. What happened?
In Q1 2019 iQiyi lost $270.3 million on $1 billion in revenue. Q2 earnings come out on Aug. 19. Analysts expect losses of $0.57 per ADR, or over $414 million. For 2019, losses are expected to be $1.87 per share, or $1.359 billion. This will burn 53% of IQ’s $2.55 billion in cash and securities.
IQiyi does not produce quarterly cash flow statements. Cash flow losses are unknown each quarter. Since content acquisition costs are almost 80% of revenue, the market assumes IQ will not be cash flow positive for at least several years.
This is where the comparison with Netflix falters. NFLX made $270 million in its most recent quarter. Even though its free cash flow burn was -$584 million for the quarter, this was only 11.6% of NFLX’s $5 billion in cash resources. That compares to 53% annual cash burn at iQiyi.
Given IQ’s hot competition, weak ad revenue, massive content costs, and huge cash flow losses, iQiyi stock is not going to be valued like NFLX any time soon.
Can IQ Stock Recover?
Yes, but IQ must convince the market its subscriber growth and ad revenue will become profitable like at Netflix. Otherwise IQ will have to finance losses by raising more debt or equity, and/or selling assets. None of this is good for shareholders.
IQ’s stock has recovered from its lows, but don’t expect it to approach previous highs any time soon. Wait before buying to see how it handles these issues.
As of this writing, Mark R. Hake did not hold a position in any of the aforementioned securities.
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