Amid volatility, iQIYI (NASDAQ:IQ) stock has been sideways since November 2018. There are notable fundamental factors that have kept market participants uncertain on the next move for IQ stock.
I believe that these factors are likely to ensure that IQ remains either sideways or falls lower in the next 12 to 18 months. This article will discuss the factors surrounding iQiyi stock, focusing on the company’s cash burn and the impact of competition.
Before discussing the bear story, I must mention that new businesses are bound to face cash burn. However, the potential to monetize key assets often determines the target stock’s direction. That’s the uncertain part for IQ. This implies leveraging or equity dilution, either of which is bound to impact investor sentiment.
The Concern on Competition
IQ is not the only player in the online entertainment service in China. This is likely to have implications on the company’s ability to generate cash.
Tencent Holdings (OTCMKTS:TCEHY), which is listed in the Hong Kong stock exchange, is one of the main competitors. For the first quarter of 2019, Tencent Video subscription was 96.9 million. For Q2 2019, IQ had a total subscriber base of 100.5 million. Therefore, both companies are head-to-head in terms of sub count.
However, IQ has an edge considering the fact that the company reported year-over-year subscriber growth of 50%. On the other hand, Tencent Video reported subscriber growth of 30% on a year-over-year basis.
According to Tencent’s quarterly summary:
Tencent Video subscription counts were 96.9 million, up 30% year-on-year, benefitting from joint membership promotions with our strategic partners and our popular self-commissioned Chinese anime series, The Land of Warriors Season 2. However, the growth in our video subscriber base slowed, due to the delay in scheduling of top-tier drama series content.
The takeaway is that new content on a regular and timely basis is the key to subscriber growth. However, if subscriber monetization is sluggish, expenses related to new content creation will always outpace revenue growth.
This is a big challenge for IQ. The company’s subscriber growth has been robust. However, subscriber fee is low and the company’s advertising service revenue has declined sharply in the recent quarter.
The company blames macroeconomic conditions for revenue decline. What follows is that advertising revenue will remain sluggish since macroeconomic conditions remain challenging. In such a scenario, IQ needs to continue investing in new content creation, which will increase the cash burn.
Weak Growth Guidance
I believe that the markets will wait for results in the coming quarters before any decisive move for IQ stock. In the meantime, iQiyi stock is likely to remain sideways to lower.
The reason for my view is as follows. For Q2 2019, IQ reported revenue growth of 15% as compared to the year-ago quarter. For Q3 2019, the company has guided for revenue growth in the range of 4% to 10% as compared to Q3 2018. Clearly, revenue growth is decelerating even if subscriber growth remains healthy.
Further, the company’s cost of revenue (the single largest expense item) increased by 14% for Q2 2019. It remains to be seen if growth in cost of revenue outpaces revenue growth in Q3 2019. That would be a major red flag.
Concluding Thoughts on IQ stock
IQ has a diversified source of revenue generation that includes membership fees, online advertising and content distribution. While member fee growth was robust in Q2, revenue decline on a year-over-year basis from advertising and content distribution was worrisome. These concerns will weigh on the stock until there is a trend reversal.
I have focused on these concerns, but there are positives for IQ stock. The subscriber base growth is robust and iQiyi has a healthy cash buffer. The company can continue to invest in high quality content in the coming years. The only major challenge will be to increase the revenue per subscriber.
Among the positives, I must add that the company launched a $300 virtual reality headset in May 2019. The virtual reality market is expected to be worth $53.6 billion by 2025. Similarly, the company’s iQiyi Mall is an e-commerce platform that sells consumer products, such as electronics, apparel, accessories, beauty and skin care products. The point here is that IQ is active on the diversification front and that should help in the long term.
Overall, near-term concerns persist for IQ stock and that will translate into sideways to marginally lower price trends. However, I do believe that the stock can be kept in the investment radar. Coming quarters can possibly provide a better entry opportunity.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
