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Here’s Why IQ Stock Remains Way Too Risky to Touch Right Now

So long as its profit problem hangs around, IQ stock will remain depressed and volatile

It’s been a rough run for iQiyi (NASDAQ:IQ) as a public company on Wall Street. The Chinese streaming giant (sometimes touted as the Netflix (NASDAQ:NFLX) of China)had a brief honeymoon phase following its March 2018 IPO. IQ stock sailed from the $18 IPO price, to nearly $50 by mid-June 2018.

Here's Why IQ Stock Remains Way Too Risky to Touch Right Now
Source: Shutterstock

Then, the honeymoon ended. IQ stock dropped to $15 by late 2018 and has been volatile and choppy ever since, ultimately gaining no ground. Investors have remained concerned with regards to China’s slowing digital economy and iQiyi’s huge losses.

Bulls are hoping second-quarter earnings due on Aug. 19 will provide an upward catalyst for iQiyi stock. I’m not convinced. iQiyi has a profit problem. This profit problem is ultimately what has weighed on the stock over the past few months. I don’t see the problem getting better anytime soon. As such, I think the recent weakness in iQiyi is here to stay.

At some point, IQ stock becomes a good buy given its long term growth potential in the (what should be) huge China streaming market. But, that point is not here, and it’s not now.

As such, for the foreseeable future, I think it’s best to steer away from IQ stock. The stock remains too risky to touch until profit trends show signs of improvement.

iQiyi Has A Profit Problem

In the big picture, iQiyi is not the Netflix of China. Whereas Netflix has figured out a way to produce sizable profits at scale in the global streaming TV market, iQiyi has yet to do the same in the structurally different China streaming TV market.

Indeed, China’s streaming TV market is so structurally different that it may be impossible for iQiyi to net a profit here, and that means that iQiyi has a big profit problem that may not go away anytime soon.

The difference between China and America’s streaming markets comes down to one difference: in America, consumers are willing to pay for content; in China, they aren’t. It’s that simple.

Netflix charges about $10 to 15 per month per subscriber. Pretty much every other U.S.-based streaming service charges the same, from Hulu to Disney+ to Amazon Prime Video. iQiyi, meanwhile, charges about $1.50 to $2 per month. That number isn’t a factor of lack of scale, either. iQiyi has nearly 100 million subs, and the average revenue per sub has been stuck in neutral for several years. Instead, it’s a byproduct of the fact that Chinese consumers simply aren’t willing to pay much for streaming TV content.

Thus, iQiyi’s unit revenue potential is significantly lower than Netflix’s unit revenue potential, but unit costs are pretty much the same. That is, even though streaming prices in China are low, the cost to produce content is not. The result? Unit revenues are lower. Unit costs are the same. Thus, the unit economics at iQiyi are significantly worse than the unit economics at Netflix.

Netflix isn’t that profitable of a company. They run at operating margins narrowly above 10%. Thus, with significantly worse unit economics, the pathway towards profitability for iQiyi lacks visibility. So long as that remains true, IQ stock will remain depressed.

Long Term Potential Is There, but Not Compelling

China’s massive digital population and huge consumer appetite for streaming content should mean that iQiyi stock has robust long term growth prospects. But, given the aforementioned profitability concerns, those long term growth prospects aren’t compelling here and now.

Qualitatively, I think that China’s streaming market will grow by leaps and bounds over the next several years as China’s consumer economy continues to rapidly digitize. I also think that iQiyi will leverage its original content strategy and scale to remain a very relevant player in this market, implying strong subscriber growth over the next few years. Unit revenues should march somewhat higher with scale. Revenue scale should simultaneously drive positive operating leverage, and margins should trend higher.

If you reasonably math out all those aforementioned assumptions, iQiyi projects as a company that could do about $13 billion in revenue by 2025, with profits that will hover around $1 billion. Assuming a multiple of 20-times its forward earnings, which is around average for growth stocks, that equates to a 2024 valuation target for the stock of $20 billion. Discounted back by 10% per year implies a 2019 valuation target of about $12.4 billion.

Leaving room for 15% error in the projections, that further equates to a 2019 fair valuation range for IQ of about $10 billion to about $14 billion. IQ stock trades in that range today. Thus, there is upside potential from here, but it’s not compelling enough given the company’s huge profitability risks.

Bottom Line on IQ Stock

Ahead of Q2 earnings, IQ stock remains too risky to touch. At its core, this company has a profit problem. Until that profit problem eases, the stock won’t stage a meaningful turnaround. I don’t see that profit problem turning around anytime soon. As such, I don’t see iQiyi stock turning around any time soon, either.

Even if it does, it’s still probably best to wait for confirmation rather than to rely on speculation. Because of this – even if the numbers are good – the best time to buy iQiyi stock will be after the Q2 print, not before it.

As of this writing, Luke Lango was long NFLX.

Article printed from InvestorPlace Media,

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