Chinese streaming platform iQiyi (NASDAQ:IQ) has had a rough run on Wall Street. Once heralded as the Netflix (NASDAQ:NFLX) of China, IQ stock soared from $15 to $50 on that favorable comparison in its first few weeks in U.S. markets. Ever since then, however, IQ stock has dropped all the way back to $15, as investors have second-guessed the Netflix comp, questioned the long term potential of iQiyi, and expressed concern regarding the valuation.
This sell-off has been exacerbated recently amid murmurs of the U.S. limiting investment into China, which could lead to a potential de-listing of iQiyi stock. Over the past three weeks alone, IQ stock has shed 20% on these concerns.
Now, shares trade hands just a few points north of all time lows. Does that mean it’s time to buy the dip in IQ stock?
No. Not yet. Long term growth fundamentals say iQiyi stock is fairly valued today around $15. I’m not a buyer until shares drop below $15. This is especially true considering near-term optics risks are quite sizable.
Big picture: don’t buy the dip in IQ stock yet. Wait for it to fall below $15, and then wait for it to show support below $15. At that point, buy the dip. Until then, stay away.
Long Term Fundamentals Say $15 for IQ Stock Is Fair Value
Zooming out, the long term fundamentals underlying IQ stock imply that $15 is a fundamentally supported price tag for this stock by the end of 2019.
The math behind this price target can be found here, but the high-level logic is as follows. iQiyi is the Netflix of China, in that the company is China’s leading streaming video subscription platform. But, China’s streaming video subscription market is much different than America’s in one very important way: price point. In America, consumers are willing to pay up for streaming services with great content. In China, for a variety reasons, consumers are not willing to pay that much for streaming services.
Because of this, iQiyi’s unit economics are much worse than Netflix’s unit economics. The company brings in much less revenue per subscriber. But, costs per subscriber are still sizable, since content costs — regardless if they are Chinese content costs or American content costs — are roughly the same everywhere. So, relative to Netflix, iQiyi operates with lower unit revenues and comparable unit costs, implying significantly lower unit profits.
Ultimately, this creates long-term profitability challenges for iQiyi. Sure, the company may one day hit 200 million subscribers in China, but profits won’t be that big at that point in time because unit revenues will remain relatively depressed while unit costs will remain sizable.
My modeling suggests iQiyi can hit about $1.20 in EPS by fiscal 2025. Assuming an exit multiple of 20-times forward earnings and a 10% discount rate, that equates to a 2019 price target for IQ stock of about $15.
Don’t Buy iQiyi Stock Above $15
Given that the stock’s fair value is right around $15 and that there are a plethora of optical risks at present, I wouldn’t consider buying IQ stock at prices above $15 today.
Just consider the following: Subscriber and revenue growth at iQiyi are slowing. Unit revenue growth is sharply negative, and accelerating in the negative direction. Operating margins are negative and dropping. Losses are widening. There is a potential de-listing on the horizon. The trade war rages on. China’s economy, while showing signs of stabilizing, is still slowing. Competition is ramping with Tencent Video and Youku.
In other words, there are a lot of optical risks with IQ stock. All these optical risks imply that investor sentiment will remain depressed for the foreseeable future. When investor sentiment is depressed, stocks don’t get the benefit of the doubt on the valuation front.
From this perspective, I don’t think IQ stock becomes a buy until it drops below $15.
Bottom Line on IQ Stock
I’m not a huge fan of IQ stock. This company has unresolved profitability and competition concerns, which cloud the long term outlook. But, the stock has been depressed for a long time, and at some point, this stock will become too depressed for its own good.
When does that happen? At prices below $15. As such, if IQ stock drops below $15 over the next few months, I’d consider buying the dip. Until then, I’ll monitor the situation from the sidelines.
As of this writing, Luke Lango was long NFLX.
