Indeed, as I noted last year, the iQiyi business model is not the same as that of Netflix. iQiyi actually is more of a hybrid between Netflix — which streams owned or licensed high-quality content to paying subscribers — and Alphabet (NASDAQ:GOOG,GOOGL) unit YouTube — which monetizes user and corporate content via advertising. 30% of iQiyi revenue in the first quarter came from advertising; the figure for Netflix is essentially zero.
iQiyi’s subscription fees are much lower, owing to its position in a still-developing market. Its reach is smaller. Competition is tougher, too. Tencent Video, from Tencent Holdings (OTCMKTS:TCEHY) and Alibaba (NYSE:BABA) unit Youku Toudu are running neck and neck in terms of paid subscribers and viewership. Hulu, now majority owned by Disney (NYSE:DIS), is Netflix’s closest pure competitor, and remains a distant second, though rivals including Disney and AT&T (NYSE:T) are on the way.
That said, those differences seem incorporated into the two companies’ stock prices, at least by one key valuation metric. Netflix (including its net debt) currently is valued at roughly $1,000 per subscriber. Hulu’s implied valuation is about $600. For iQiyi, the figure is just $140.
As imperfect as is the comparison between the two companies, the gap highlights a broader split in the market. The choice between IQ and NFLX comes down to an oft-asked question these days: would you rather invest in the U.S. and its Western allies or in China?
The China-U.S. Split
The split between iQiyi stock and Netflix stock isn’t surprising — or unique. U.S. companies generally get higher valuations. Amazon.com (NASDAQ:AMZN) has higher multiples than Alibaba or JD.com (NASDAQ:JD). Exxon Mobil (NYSE:XOM) gets a higher earnings multiple than PetroChina (NYSE:PTR). Even the Hong Kong-listed Chinese units of gaming giants Wynn Resorts (NASDAQ:WYNN) and Las Vegas Sands (NYSE:LVS) historically have traded at a discount, relative to the implied value of those companies’ U.S. businesses.
From one standpoint, that gap makes perfect sense. China, after all, remains a Communist country, at least in name. There are more risks with doing business in that country — and in owning shares. Investors don’t entirely trust the country’s economic figures, with good reason. And there’s long been a fear that China’s roaring growth — even if it’s lower than reported figures suggest — is going to come an end at some point.
But on the other hand, those fears seem to undersell just what an opportunity China is. For a company like iQiyi, it’s worth remembering that more than half of the country’s households still don’t have Internet access. There may be macro cycles like anywhere else, but there is also decades’ worth of potential growth as hundreds of millions of Chinese move into the middle class over time.
It’s not unreasonable to prefer Chinese stocks to U.S. ones at this point. With the S&P 500 at all-time highs, there’s obvious risk in U.S. stocks, too. The trade war creates near-term uncertainty, but will resolve at some point. It’s possible the opportunity in Chinese stocks — which mostly are cheaper than they were a year ago — is greater than that of the U.S.
IQ Stock Still the Play
For investors bullish on China, iQiyi stock still looks like the best play, as I wrote last month. The gap in per-subscriber valuations between iQiyi, Hulu, and Netflix might make some sense at the moment, but iQiyi might have a larger opportunity over the long haul. It’s not just China, either: iQiyi has started distributing in Malaysia, and like many Chinese firms has the potential to reach across all of Southeast Asia.
IQ stock looks attractive particularly for those who see the relative valuations of U.S. stocks and Chinese stocks as lopsided. In the other cases, the Chinese stocks have potentially significant issues. Alibaba has a questionable VIE structure. The Macau casinos long have been linked to money laundering and other practices.
iQiyi, on the other hand, is cheaper simply because it’s a Chinese company. That logic might well be wrong. If it is, IQ stock will have enormous upside ahead.
As of this writing, Vince Martin has no positions in any securities mentioned.