Nobody really expected China’s streaming outfit, iQiyi, (NASDAQ:IQ) to turn a profit in its infancy. Speculators stepped into IQ stock anyway, anticipating a slow but discernible shift towards profitability would propel the shares higher.
If that’s going to happen at all, it’s likely to happen within the next three years. If it doesn’t happen by then, it may not occur at all.
Given that powerhouses like Tencent (OTCMKTS:TCEHY) and Alibaba (NYSE:BABA) are also in the streaming business and reasonably well-entrenched within the Chinese market, it would be easy for the owners of IQ stock to fear the worst. That’s particularly true given that IQ’s revenue surged last quarter, but its operating costs grew even more. Its losses are still tremendous, despite its top-line growth, and the 35% setback iQiyi stock has suffered since March’s high shows that the market is concerned about the company’s outlook.
The next three years are going to look much different than the past three have, however,as IQ’s capabilities will greatly increase.
IQ Is Tweaking Its Ad Business
IQ has been called the Netflix (NASDAQ:NFLX) of China, and understandably so. But, there are differences between the companies. While IQ does sell subscription-based access to original content, its user-generated content and video advertising business looks comparable to that of Alphabet’s (NASDAQ:GOOGL, NASDAQ:GOOG) YouTube.
Unlike YouTube, though, IQ hasn’t yet mastered the art of cost-effectively connecting advertisers with the right consumers. Last quarter, its ad revenue of $316 million was flat year-over-year.
In some ways, it’s unfair to complain about the company’s flat ad revenue. China’s economic headwind has forced some advertisers to pare back their spending in an environment that’s already pretty well saturated with ads. At the same time, IQ has made a point of putting more emphasis on content creation that can be used to sell more profitable subscriptions.
Regardless, realizing there’s money on the table to be taken, IQ continues to refine its approach to selling ads. China’s search engine giant Baidu (NASDAQ:BIDU), which owns the majority of IQ stock, continues to help the video platform tweak its advertising business.
Where IQ is soon going to make radical changes, however, is on the original content front.
More Content, More Places
The ramp-up has already started, with content costs growing 38% in the first quarter. The $943 million IQ spent on its home-grown shows and movies in Q1 was roughly twice as much as its subscription-driven revenue last quarter, and almost the same amount as its total Q1 revenue of around $1 billion.
Unlike Netflix, though, iQiyi has a plan to sell much of its original content to other broadcasters.
Case in point: Its crime drama The Thunder, which received rave reviews in China, is set to be aired on HBO property Red in the foreseeable future.
More multi-channel distribution is in the cards. CEO Gong Yu made clear in an interview last month that for its original films “the first window of opportunity is still to screen them in movie theaters. The second window of opportunity is to show them on iQiyi, so as to maximize the total revenue.”
Netflix has released films in theaters as well, but only on a small scale, and only as a means of securing eligibility for film awards. For iQiyi, the approach is being viewed as a profit center in and of itself.
It’s a new development and could require some clever experimentation, since China’s box office revenue is currently declining meaningfully
IQ to Utilize AI Throughout Its Business
In recent months, it has become possible for artificial intelligence to create perfectly convincing video that would be difficult and expensive (if not impossible) to shoot by traditional means.
But IQ’s CEO said the company may not start to use that technology for another 8-15 years. However, the company may not need that much time to at least begin enjoying the lowered costs that artificial intelligence-produced video facilitates. Many of the recent blockbuster superhero films have successfully utilized AI to create scenes that movie-goers enjoyed without a moment of doubt or distraction.
Moreover, IQ currently uses artificial intelligence to determine which films and videos to produce in the first place.
The Bottom Line on IQ Stock
These shifts are noteworthy now because they’re all new. It remains to be seen, however, if they will be able to turn the tide for IQ stock. But, even if they are the much-needed changes the company needs, they like won’t gain much traction this year.
“The bigger question will still be when content costs can fall, and we do not expect that to happen in 2019 as shows purchased last year were still expensive, and costs will be amortized this year,” noted Bernstein analyst David Dai.
Bernstein currently has an “underperform” rating on iQiyi stock.
But those who can hold IQ for the long-term could benefit from these changes.
Shelleen Shum, the forecasting director for eMarketer, is optimistic about that. She commented, “[iQiyi’s] investments in premium content have clearly helped to attract more subscribers. A growing user base will add not only to its membership revenue but also help its ad business remain competitive.”
She added, however, “Currently, video platforms’ methods for profit are generally in advertising, paid membership business, and IP development. Among these, homegrown IP and tapping IP value are key for profit, but the period needed is relatively long.”
But how long will the owners of IQ stock wait for IQ to prove it can work its way into the black? Three years is a plausible, defensible time frame, provided it meets the important milestones in the meantime.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can learn more about James at his site, jamesbrumley.com, or follow him on Twitter, at @jbrumley.