IQiyi Stock Is Perfect, But Only for a Specific Kind of Investor

IQ stock - IQiyi Stock Is Perfect, But Only for a Specific Kind of Investor

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The story surrounding iQiyi (NASDAQ:IQ) really is in the eye of the beholder, which partly explains the lumpy trading in IQ stock since its March IPO.

Indeed, iQiyi stock raises a number of questions that don’t necessarily have a “right” answer.

How does an investor feel about growth stocks in general? Is she willing to assign a $21 billion market cap — or higher — to a company that doesn’t make any money? Should IQ stock trade at a discount to Netflix (NASDAQ:NFLX), its most commonly cited peer, owing to its Chinese domicile and lower subscriber rates? Or does the immensity of the Chinese market — along with potential expansion elsewhere in southeast Asia, and perhaps beyond — suggest iQiyi has a path to equal or surpass the heights reached by NFLX stock?

These aren’t easy questions to answer.

Nor is it simple to assign a useful fundamental valuation to a company with negative earnings and cash flow. Is a current ~6.3x EV/revenue multiple too high or too low? Should IQ stock really be compared to NFLX or should it be compared to other Chinese Internet plays like Weibo (NASDAQ:WB) or its 70% owner Baidu (NASDAQ:BIDU)?

They are all interesting questions, and they make iQiyi stock one of the more interesting stocks in the market. From here, the answers are good enough to suggest that the stock is probably undervalued at $30, at least for risk-tolerant investors.

But the number and difficulty of the questions, and the recent volatile trading in IQ stock also suggest that investors might do well to have some patience, or at least hedge their initial bets.

IQ Stock: The Risks Need to Be Noted

I wrote last month that stock in iQiyi looked attractive for China bulls, but I advised patience at $33. After Q2 earnings, and with the IQ stock price down almost 10%, my perspective hasn’t changed all that much.

After all, there are risks here, as my fellow InvestorPlace writers have pointed out. For example, Tom Taulli highlighted overall weakness in Chinese stocks (that country’s major index has entered a bear market) and competition from Alibaba (NYSE:BABA) and Tencent (OTCMKTS:TCEHY). Josh Enomoto pointed to the company’s widening net loss even as it grows.

More broadly, it doesn’t take much analysis to understand that iQiyi stock is a risky play. A Chinese stock worth $21 billion with zero profits is pretty much only for aggressive investors … at least by definition. A convoluted corporate structure is reminiscent of Alibaba’s setup, and it could raise similar accounting concerns. While stock in iQIYI is often compared to Netflix, it’s not exactly the same. The company is far more reliant on advertising, and it generates far lower subscriber revenue on a per-user basis (about $3-per-month) than NFLX.

The Case for iQiyi Stock

For certain investors, then, IQ stock is a “no go” from the jump. But for those willing to take on the risk, and especially those who are bullish on China, there’s an attractive story here.

To be sure, IQ isn’t the same as Netflix. But it’s not like IQ stock is valued like NFLX. Netflix has close to triple the paying users (192 million versus 66 million for iQiyi). Those users are valued by the market at about $855 each, against roughly $300 for IQ.

If we assume iQiyi can get to Netflix’s user count in six years (20% growth, a notable deceleration from the 75% increase in Q2), and that its per-user figure will be half of Netflix, IQ’s market cap would get to $82 billion. Discounted back even at 10%, that values IQ stock right now at over $60.

Obviously, that’s a bullish scenario in terms of both user value and user growth. But it’s not impossible. And it provides some fundamental justification for a story that many investors might see as hugely attractive. After all, some might see a Chinese stock with no profits and a $21 billion valuation as a negative.

But given the company’s massive opportunity, and the fact that it’s spending up for growth, others might see the stock as a huge opportunity, particularly with the IQ stock price one-third below its June highs.

How to Play IQ

The real question — even for investors who like the story here — is whether $30 is not just a good price, but the best price for the stock. After all, iQiyi stock was at $25 just a couple of weeks ago. Chinese stocks have rebounded a bit of late, but with trade war worries, there could be another leg down ahead, which might bring iQiyi down with it.

There are some ways to take a hedged position in IQ’s stock. Selling puts can garner premium and lower the effective entry price. The Jan 2019 $25 put can be sold for $1.80, for instance. That provides a 7%+ return over less than 5 months. In a worst-case scenario, an investor would pay $23.20-per-share (plus commissions, to which traders must pay attention) for IQ.

Similarly, investors also can hedge iQiyi stock by shorting other Chinese stocks. In that outcome, any market-wide decline in China would be offset by the short position, leaving the trade as a bet on iQiyi outperforming.

Or — and this would be my advice — IQ investors could just stay patient, and look to nibble. I do think $30 is an attractive price for IQ stock in the long-term … for the right kind of investor. But recent trading suggests those investors might be able to do even better at some point.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.


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