Chinese streaming giant iQiyi (NASDAQ:IQ) – often dubbed the Netflix (NASDAQ:NFLX) of China – started off life on Wall Street with a bang. The company went public at $18 a share in March 2018, and by June 2018, IQ stock was above $45 as investors were drooling over the growth potential of China’s video streaming market.
But, three things have happened since that June 2018 peak which have caused IQ stock to drop to below $20 today.
First, China’s economy slowed, mostly as a result of rising trade tensions between the U.S. and China. Second, investors realized that China consumers aren’t willing to pay that much for a streaming service, yet. Third, despite big top-line growth, iQiyi’s bottom-line has failed to make meaningful progress.
Broadly, then, a more negative backdrop, questions regarding long term potential, and sluggish margin progress have ultimately kept investor sentiment on IQ stock relatively depressed.
Sentiment will remain depressed until those three headwinds clear up. Unfortunately, those three headwinds don’t project to clear up anytime soon. As such, while IQ stock does have a huge upside potential from here, the stock likely won’t realize that potential for several more months.
Upside Potential Is Big
Internet TV is the future of video consumption globally. Leading this global pivot into internet TV are the U.S. and China. But, because China has more people, China’s streaming video market is much bigger than America’s streaming video market. According to Ampere Analysis, the number of streaming subscribers in China will be nearly double that of streaming subscribers in the U.S. by the end of this year (305 million in China, versus 157 million in America).
Still, at 305 million subscribers, that’s only about 35% of China’s internet-connected population. The U.S. has a streaming TV penetration rate of about 60%. That’s why Ampere sees China’s streaming market growing to almost 400 million subscribers by 2023.
iQiyi is at the center of this huge and rapidly growing China video streaming market. Last quarter, the company reported nearly 100 million paying subs, up nearly 60% year-over-year. Thus, iQiyi is not only a very big player in this market (nearly 40% market share) but also one that is rapidly expanding its dominance.
Given all that, the math here for big upside is easy to follow.
China’s streaming market hits 400 million subs by 2023. iQiyi takes home 40% share, so 160 million subs. Let’s assume they can get prices to $5 per month, cheap by U.S. standards. That would yield $9.6 billion in streaming revenue. Assuming the online ad business measures around $2-3 billion by then, you are easily looking at $12 billion in revenues by 2023.
Further, assuming operating margins can scale towards 10% (where Netflix has them today), that would flow into about $1 billion in net profit after taxes. Put a 20 multiple on that, and you’re looking at a $20 billion market cap.
IQ stock has a $13 billion market cap today.
Big Risks to the Bull Thesis
Although the IQ bull thesis is compelling on its surface, there are big risks that reveal themselves upon closer inspection of the company and its fundamentals.
First, China consumers aren’t accustomed to nor do they want to pay up for a streaming service. Netflix charges around $10 per month, and that’s pretty much the going rate in the U.S. for streaming services. But, iQiyi reported membership revenue of roughly $1.5 billion last year on an average sub-base of 69 million. That means iQiyi brought home just under $2 per month on average from each one of its paying subscribers.
That’s tiny. Thus, the aforementioned $5 per month price point seems like a stretch. Maybe it winds up being just $3-4 per month. Doing the same math as above, that price point produces a future market cap target of just under $15 billion. That’s a limited upside from today’s levels.
Second, iQiyi’s margins aren’t making much upward progress. The company is still running huge losses, and those losses aren’t narrowing. Operating loss margin actually widened last year and total losses increased year-over-year, same with last quarter.
The problem here is that at $2 per month, iQiyi isn’t taking home enough in revenue per subscriber to really create a clear pathway towards profitability. Further, assuming that the price point does max out around $3-4, the upside potential in margins is limited.
Overall, while iQiyi stock does have huge upside potential in an everything-goes-right scenario, present headwinds cloud visibility towards that everything goes right scenario. So long as these headwinds stick around, IQ stock will have a tough time rallying.
Bottom Line on IQ Stock
iQiyi is the Netflix of China, but China’s streaming market is very different than America’s streaming market, and iQiyi’s composition is very different than Netflix’s composition.
As such, while there is a possibility for IQ stock to turn into a huge winner, the present outlook remains troubled, meaning investors should probably wait for more signs of strength before jumping in.
As of this writing, Luke Lango was long NFLX.
