iQiyi (NASDAQ:IQ) is a fast-growing Chinese online streaming and entertainment company. Since early March, however, iQiyi share price has stumbled. The decline corresponds in part to the escalation of the U.S.-China trade tension and in part to other fundamental worries investors have about the state of the Chinese economy.
Although iQiyi shares will likely reward long-term investors for many years to come, it may nonetheless continue to be volatile over the next few weeks. Yet investors may see any further price declines as good opportunities to go long IQ stock. Here’s why.
IQ Stock and Investing in the Growing Chinese Consumer Economy
IQiyi stock is a spin-off from China’s search leader Baidu (NASDAQ:BIDU). IQ was initially an ad-supported, video-on-demand service. Then in 2015, BIDU adopted Netflix’s (NASDAQ:NFLX) pay-for-content subscription model and started charging about $3 per month for original content.
After the service grew, Baidu decided to spin it off and, subsequently, IQ stock had its IPO in March 2018. IQ stock now offers investors the enticing possibility of investing in the growing Chinese consumer economy. After Tencent Video, which is owned by Tencent Holdings (OTCMKTS:TCEHY), IQ is the second-largest video platform. It is now referred to by many as the “Netflix of China.”
Thus, those who own IQ stock will be able to participate in the growing online video market in China, where the number of paying subscribers is expected to pass 300 million in 2019. IQ is well-positioned to capitalize on this trend. Additionally, many analysts expect IQ to expand into the rest of Asia.
IQ Stock’s Recent Earnings Failed to Impress
Total revenues were RMB7.1 billion (US$1 billion), representing a 15% increase from the same period in 2018. IQ has three main revenue streams:
- Membership services (subscribers can view new, exclusive contents without ads);
- Online advertising services (non-paying viewers must watch a 90-second advertisement before seeing any content);
- Content distribution (iQiyi receives these fees in exchange for licensing its original content).
In other words, IQ’s management has so far been building a rather diversified business model.
IQ stocks subscription revenues grew 38% year-over-year to reach RMB3.41 billion. Membership fees now make up about 48% of total revenues. iQiyi’s original content ranks among the most popular shows in China. And management believes the growth in membership numbers reflects the strength of the streaming platform’s premium content.
Online advertising services revenue was RMB2.2 billion (US$320.6 million), down 16% YoY. Management blamed “the challenging macroeconomic environment in China, the delay of certain content launches and slower-than-expected recovery of in-feed advertising” for the decrease in revenue.
Content distribution revenue was RMB517.9 million (US$75.4 million), a 4% decrease from the same period in 2018.
IQ stock’s total number of members was 100.5 million as of June 30, 2019, 98.9% of whom were paying subscribing members. This compares to 67.1 million of total subscribing members as of June 30, 2018, up 50% YoY. By comparison, Netflix has about 150 million subscribers globally.
iQiyi is still a high-growth company and analysts expect the next several earnings report to show that its P/E growth rate is over 35%. This growth in revenue is expected to trickle down to the company’s bottom line in the coming years.
IQ Stock is Not Yet Profitable
Despite the expected growth rate, one thing investors need to keep in mind is that iQiyi is not yet a profitable company. Its net loss widened to RMB2.3 billion (US$339.0 million) from a net loss of RMB2.1 billion in Q2 2018.
IQ stock’s operating loss margin also worsened to 26%, compared to 22% a year ago.
Its management underlined that as the company further invests in technology and builds content, the cost of revenue would be high, i.e., the company will not be profitable any time soon.
Going forward, the important question remains whether investors will continue to accept the large amounts of money that IQ stock has to pay for high-quality content. In other words, when will the cash burn start to pay off?
Analysts value iQiyi stock based on the expectation of continued high revenue growth, which would lead to future profits. Therefore, whenever Wall Street fears the company is failing to meet growth or expectations, the stock will get penalized.
In other words, long-term investors should be ready for daily price fluctuations as well as high volatility, especially around earnings release dates.
Headwinds for iQiyi Stock in China
In addition to stock-specific speculative moves, investors should consider the current global trade wars and the state of the Chinese economy. Recently, several analysts have warned that China, the world’s second-biggest economy, has slowed considerably.
Due to weaker economic growth, many Chinese companies have trimmed their marketing spend. As a result of the weak advertising market, IQ’s quarterly results have suffered.
Similarly, its parent company Baidu’s online ad revenue has been plummeting. It may be several quarters before IQ stock’s adverse advertising revenue trends begin to improve.
Although the trade wars may not necessarily have much impact on iQiyi’s business, the uncertainty has dampened investor confidence in Chinese stocks overall. Like many of its Chinese internet counterparts, iQiyi share price has been a major loser this year.
Markets suffer during times of uncertainty and in the coming months, I expect the IQ stock price to be a battleground between investors and traders. As a result, there might be a weakness in the IQ stock price in the near term that investors should anticipate.
Where IQ Stock Price Is Now
Since late February, IQ stock has fallen over 35%, from a 2019-high of $29.18 to a recent 2019-low of $16.41. It is currently hovering around $17.5.
In March 2018, iQiyi priced its U.S. initial public offering at $18. Now that the share price is approximately at the level of the IPO price, many investors are wondering whether they should buy IQ stock.
As result of this decline, IQ stock’s technical charts look weak. iQiyi share price will need to build a base before a sustained rally can take place.
New investors may want to consider buying IQ if the stock goes below $16.5-$17. IQ stock will become very attractive as it moves toward the $15-level.
Current owners of IQ stock may also consider hedging their positions. As for hedging strategies, covered calls or put spreads that expire on Oct. 18 could be appropriate, as straight put purchases are likely to be expensive due to heightened volatility.
The Bottom Line on IQ Stock
Volatility and stock markets go hand-in-hand. And the continuing U.S.-China trade war has affected many shares negatively. When fear prevails, logic can easily get thrown out of the window and many stocks decrease to price levels that make them much cheaper than they were several months ago. One such stock that has felt the squeeze recently is iQiyi stock.
Although IQ stock will likely reward long-term investors, it may continue to be volatile over the next few weeks. And I do not expect to witness a major favorable sentiment shift toward Chinese stocks. However, although short-term investors should expect daily price swings in the IQ stock, long-term investors may see any further price declines as opportunities to go long.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.