Investors should exercise caution investing in companies that are both losing money and are listed in China. Such is the case with iQIYI(NASDAQ: IQ). Escalating trade wars between the U.S. and China scared investors away from China-based companies and that move has been costing iQIYI stock.
Even after JD.com (NASDAQ: JD) and Alibaba Group (NYSE: BABA) reported solid quarterly sales growth, the stock failed to return to yearly highs. So, with iQIYI reporting first-quarter revenue growth of 43% but a loss of around $270 million, what is there to like about this company?
iQIYI’s subscriber base grew an impressive 58% to 96.8 million, up from 61.3 million last year. Revenue grew 43% but net losses doubled to around $270 million. The company effectively strengthened its platform with user growth and attracted new users, increasing overall user stickiness in the quarter.
Both DAU on the mobile app and time spent grew in the double digits, demonstrating effective marketing campaigns and premium content resonating with users. The Legend of Haolan, The Golden Eyes and The Legend are examples of premium, high-quality original drama driving subscriber growth.
iQIYI’s secondquarter revenue guidance of 6.91 billion – 7.29 billion yuan (USD $998 million – $1.05 billion), up 12-18% Y/Y is disappointing investors with a short-term time horizon. Revenue growth lags with the subscriber additions. If the time spent per user increases, expect iQIYI reporting higher revenue later this year.
Still, the company reported ad revenue remaining largely flat compared to last year. It is maintaining a cautious outlook, factoring the macroeconomic weakness in China that is driven by the ongoing trade disputes.
Opportunity in iQIYI Stock
iQIYI’s self-produced content, premium content, and ad solution should keep a positive business momentum despite the macro headwinds ahead. Viewership should grow, driven by advertising initiatives to attract new subscribers. IQIYI is building multiple business engines to diversify.
Its gaming business performed well in the first quarter while its content unit will incorporate more Chinese cultural values. The richer its content library gets, the wider an audience iQIYI will attract.
IQIYI is exploring the prospects of 5G with China Unicom. It launched an 8K VR visual experience center in March. Its “Qisubo” service integrates CDN technology with 5G Mobile Edge Computing and ensures high frame rates for videos having lots of interactivity. As Qisubo matures, its service may be used in hotels, high-speed trains, airports, universities, and anywhere high-quality video content is displayed.
Headwinds for iQIYI Stock
With all the strong growth prospects ahead, investors cannot ignore the growing expenses and quarterly loss. SG&A expenses rose 62% in the first quarter, primarily due to higher marketing spend and increased share-based compensation. R&D costs, which rose 54%, is expected for a technology firm that must invest to stay ahead.
Falling content costs could offset the other expense increases. Policy changes and regulatory censorship may have contributed to its 20% sequential drop in content costs in Q1. Looking ahead, the company expects steady content costs for the second and third quarter.
Subscriber growth outpaced competitors but could slow if its peers counter iQIYI’s successful initiatives. Still, strong original content and variety shows like Idol Producer resonate well with viewers.
Revenue from advertising could continue lagging as the trade war remains unresolved. On the flip side, a resolution between the U.S. and China would lead to a strong rally in IQ stock. Investors will anticipate a rebound in ad revenue as trade levels rebound and the economy in China strengthens.
Valuation and Your Takeaway on iQIYI Stock
IQ stock is getting close to its IPO price of 2018. Analysts are cautious of the stock’s upside, predicting a gain of just 9%. In a five-year DCF revenue exit model, iQIYI needs revenue growing 25% annually to justify a fair value of $20.50. But after the stock fell almost 30% in the last quarter, the selling momentum needs to subside before the stock has any chance of drawing buyers again.
Ideally, the U.S. and China resolve their trade dispute differences. If they do not, the stock will underperform. And since fundamentals are strong for the long-term, investors willing to hold the stock for more than a year should consider iQIYI at these levels.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.