When iQIYI, Inc. (NASDAQ: IQ) began 2019 trading at around $15, the stock faced one big macro headwind related to the U.S.-China trade wars. Fast forward to today and the market’s worries over trade concerns all but disappeared. IQ stock has grown 40% in the meantime.
Investors have many China-based companies to pick from, including Alibaba Group (NYSE: BABA) and Baidu, Inc. (NASDAQ: BIDU). What are some of the reasons to consider iQIYI as an investment opportunity?
Strong Fourth Quarter for IQ Stock
iQIYI is still nearly a month away from reporting results, scheduled for May 23 after market close. But in the fourth quarter, the company reported a solid 72% year-over-year subscriber growth. It now has 87.4 million subscribers.
Within that, the membership business is driving much of the 76% revenue growth in the period. The company improved user stickiness and driving subscriber conversions by adding premium content.
iQIYI added a number of popular theatrical movies to its platform. That also helped play an important role in driving subscription growth. Added by its joint membership program with JD.com (NASDAQ: JD), annual subscriptions came in steadily during the fourth quarter.
Growth in Advertising
iQIYI reported advertising revenue growing 9% year-on-year. By enhancing its advertising platform, the company sold vertical and interactive ads. This includes its first portrait mode short-form drama series, Ugh! Life!.
Investors should expect the company creating more original content. This, in turn, will draw more advertisers. Over 50% of iQIYI’s ad revenue was for original and licensed content.
The company has two main categories of self-produced content. Variety shows are used mainly for advertising monetization. Drama series is geared towards driving membership. Here, the company does not emphasize the advertising business.
Although the revenue stream can vary from quarter to quarter, revenue levels depend on the content. So long as the company releases one or two hit quality shows in the period, expect ad revenue growth in the double digits.
iQIYI clearly demonstrated strong fourth-quarter results that suggest the upcoming quarter will please investors. While subscription grew, advertising improved and revenue was solid. But investors should notice that the company also burned through plenty of cash. In December 2018, the company sold convertible senior notes worth $750 million. This will diversify the company’s financing options and investments.
For the upcoming first quarter, iQIYI expects total revenue to be in the range of RMB6.8 billion to RMB7.1 billion. This represents an increase of 40% – 46% year-over-year.
Cash Flow Risks
iQIYI’s cash flow growth could improve. Total cash flow is hurt by total content costs. As the company increases its percentage of original content, cash flow worsens because iQIYI needs to pay for all of the content. The medium to long-term benefit of this content purchase is that it could attract and retain more advertisers.
Valuation and Target Price on IQ Stock
iQIYI has a manageable debt/equity of 0.47 times. The company is not expected to raise significant debt in the near-term. At a price/book of 6 times, the stock is inexpensive compared to Amazon.com, Inc. (NASDAQ: AMZN) at 21 times. Conversely, its P/B is above that of Alphabet Inc. (NASDAQ: GOOGL) the firm that owns YouTube.
On Wall Street, only two analysts cover IQ stock and have an average price target of $24. According to Tipranks, though, the stock did not get any ranking updates in nearly a month. The lack of coverage could explain the stock peaking at close to $30 in February and drifting down to the $23 range recently.
The downtrend in IQ stock could end at any time. Valuations are not favorable even after the dip but the stock’s strong subscription growth cannot be ignored.
Original content purchases are paying off and attracting plenty of advertisers. Investors can be assured that revenue will continue to grow in the solid high double-digits.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.