Chinese streaming TV giant iQiyi (NASDAQ:IQ) — often dubbed the Netflix (NASDAQ:NFLX) of China — reported second quarter numbers in late August that weren’t all the great. Revenues came in line with expectations, but revenue growth slowed meaningfully from the prior quarter. Profits, meanwhile, missed expectations, as operating losses widened year-over-year amid heavy content spend.
In response to the sub-par results, IQ stock dropped.
Zooming out, the big picture idea here is that iQiyi’s second quarter earnings report wasn’t good enough to warrant buying IQ stock. Instead, it didn’t ease any of the company’s major fundamental issues, and implied that the fundamentals will remain depressed for the foreseeable future.
As such, it is likely that iQiyi stock will remain depressed for the foreseeable future, too.
The investment implication? Continue to avoid IQ stock. Fundamental challenges remain, and so long as they do, IQ stock will remain similarly challenged.
Second-Quarter Print Wasn’t Enough
Heading into the Q2 print, iQiyi had a few big challenges.
First, iQiyi’s unit economics weren’t good, as the company rakes in very little revenue per subscriber but pays out a ton in content and marketing costs per subscriber. Second, iQiyi’s revenue growth trajectory had been slowing significantly due to challenges in the company’s digital ad business. Third, the company was running wide losses against a slowing growth backdrop.
None these challenges were addressed in the Q2 report. Instead, second quarter numbers affirmed that these challenges remain very real.
iQiyi’s average revenue per user dropped a whopping 23% year-over-year in Q2. To be sure, a bulk of that decline was driven by the tumbling digital ad business. But, excluding digital ad revenues, ARPU still dropped year-over-year. Revenue growth slowed to 15% – from over 40% in Q1 — and is expected to slow to below 10% next quarter. Operating loss margin widened from -21.5% in the year ago quarter, to -26.3% this quarter.
In other words, iQiyi isn’t growing unit revenue, is suffering from a slowing growth trend, and the margin profile is deteriorating. That’s a losing combo. So long as this losing combo hangs around, IQ stock will remain weak.
iQiyi Stock Remains Overvalued Considering Fundamental Challenges
Zooming out and seeing the big picture, iQiyi does have healthy long-term growth prospects. But, those long-term growth prospects aren’t good enough — yet — to warrant an $18 price tag for IQ stock.
Broadly speaking, my modeling remains largely similar to what it was before the Q2 print (see the math here). The only big differences are that I’m reducing my long term ARPU outlook slightly given continued negative trends on that front, and that I’m cutting my long term forecast for the digital ad business given macro challenges in the China ad market.
Net net, I now think that iQiyi will be able to do about $12 billion in revenues by 2025, with roughly 10% operating margins. That combination makes $1.20 seem like a doable EPS target for iQiyi by 2025. Based on a growth stock average 20-times forward multiple, that implies a fundamentally supported 2024 price target for IQ stock of $24.
Discounted back by 10% per year, that equates to a 2019 price target of about $15. That’s notably lower than today’s price tag.
Bottom Line on IQ Stock
iQiyi is an interesting growth company in China’s burgeoning digital economy. But the company also has fundamental challenges: depressed unit economics, a tumbling digital ad business, and weak and deteriorating margins. The second quarter print confirmed that those challenges remain as real today as they’ve ever been.
So long as those challenges hang around, IQ stock will remain weak.
As of this writing, Luke Lango was long NFLX.