China’s iQiyi (NASDAQ:IQ) continues to struggle. IQ stock price has fallen by over 40% from its June highs. While the trade war will probably not weigh on iQiyi, the company’s financial results have been weak. Until the outlook for IQ stock improves, investors should probably stay away from the shares.
iQiyi Has Effectively Executed on Its Strategy
Admittedly, iQiyi’s business should attract interest from investors. As a sort of hybrid of YouTube and Netflix (NASDAQ:NFLX), it operates a free service with ads in conjunction with an ad-free paid service.
Like Netflix, the company has invested heavily to improve its content. It also has emulated Netflix in many other ways. For example, iQiyi runs what it calls the “Swan Project,” a program that is supposed to groom undiscovered acting talent. Additionally, iQiyi made a deal with Eros International to add popular Bollywood movies to its lineup. I also think that its idea to create a simplified app for seniors is a concept which American tech companies should have embraced years ago.
As much as I like what the Chinese company has done on the technology and content fronts, IQ stock remains a different story. IQ stock has declined in large part due to the U.S.-China trade war. As I implied in an earlier article, selling in the wake of the trade dispute is now a case of taking the right action for the wrong reasons.
Much like the company from which it spun off, Baidu (NASDAQ:BIDU), iQiyi does not operate in the U.S. Its American connection begins and ends with a licensing agreement with Netflix to utilize the American company’s content. As a result, iQiyi will not be directly impacted by the trade war between China and the U.S. Nonetheless, IQ stock price has fallen from a high of $46.23 per share to around $27 per share today.
IQ Stock Faces Too Many Near-Term Financial Challenges
The decline of the IQ stock price may tempt some investors to buy the shares. However, I believe the selloff of IQ stock has been justified. I think that investors who missed out on Netflix should not yet look at iQiyi stock as a second chance.
One problem involves the supply of iQiyi stock. On September 25, there was a lockup expiration on 125 million shares. This massive increase in the number of shares will likely push the price of IQ stock further down.
iQiyi has also struggled to improve its profitability. As of last quarter, the company’s year-over-year revenue increased by over 42.6%. Unfortunately, the cost of that revenue rose by 38.9%. As a result, an impressive increase in its customer base has lead to only negligible improvements in its profitability.
iQiyi Needs More Paid Subscribers
The proportion of paid to unpaid subscribers likely explains this issue. iQiyi had 421 million monthly active users in January. However, as of August, only 66 million people subscribed to its pay service. I like the idea of offering some free services because they generate interest in the site. However, this pay service only offers customers ad-free access to the same content that users of the free service see. In my view, iQiyi should make people pay to see premium content.
While the company makes a lot of Netflix-like moves, IQ does not earn Netflix-like profits. According to analysts, iQiyi will not make a profit until at least 2020, and only one analyst expects it to be profitable in 2020. Like its Chinese tech peers, IQ stock will probably fail to match the valuation of its American counterpart. However, I think a more convincing path to profitability would at least cause iQiyi stock to rise significantly.
The Bottom Line on IQ Stock
Given the near-term challenges IQ stock faces, investors should stay away from the name for the time being. From a strategy perspective, I think iQiyi has executed well. However, the stock itself faces challenges. The increase in the supply of available shares rise will hurt the stock in the short-run. Moreover, the company’s customer acquisition costs are barely below the marginal revenue generated by each new customer. I think IQ stock would rise if the company offered its exclusive content only to paid subscribers.
Such a move would probably generate something IQ stock desperately needs: a profit. Like its Chinese tech counterparts, I do not think IQ stock will reach the valuations that American tech companies have attained. However, if iQiyi’s profits rise, iQiyi stock could be worth buying sometime in the future.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.