China-based companies including Alibaba Group (NYSE:BABA) and Baidu, Inc. (NASDAQ:BIDU) staged a rebound on the stock market. Yet iQiyi (NASDAQ:IQ) gave up its rally back to the $20 level after its quarterly earnings report. At a 31% subscriber growth rate year-over-year to 105.8 million, what is there not to like about IQ stock? The revenue mix is more favorable and predictable than before, too.
iQiyi reported a quarterly net addition of 5.3 million subscribers in the third quarter. Subscription revenue, a highly desirable source of stable growth, increased 30% and accounted for more than half of iQiyi’s revenue.
It accomplished this by developing its premium content, upgrading user membership experience, and growing in lower-tier cities.
Just as Western online-based video companies achieve strong user stickiness, iQiyi is doing so too through its content. Its high-quality content drives users to subscribe.
Episodic releases and original dramas are the main content types viewers enjoy. Plus, subscribers had early access to variety shows like Mr. Housework. Such reality shows increased the perceived value of a premium membership and strengthened member retention.
In August, iQiyi soft-launched a multi-lingual app available globally. If it gains traction, it will continue the launch with local language support in such Asian countries as Malaysia, Thailand, and Indonesia.
In Greater China, it will target Hong Kong, Macau, and Taiwan. Although an English-based version is available, investors should not expect the app to gain meaningful subscriptions outside of the Asian region.
iQiyi reported advertising revenue falling 14% year-over-year. Despite the setback, the company is developing its ad platform to better match the content with relevant advertisements.
Investors sent IQ stock down 10% in the last week to reflect the headwinds in its ad business. Besides, the ongoing lack of a trade deal between the U.S. and China is a broader risk factor for iQiyi stock. Still, iQiyi is advancing its ad technology. It introduced interactive ads for the very first time in the third quarter.
For example, it integrated such ads in The Big Rap of China Season 3. Ad impressions increased by 30%. Looking ahead, the higher-quality user behavioral data collected will enable iQiyi to improve its advertising offering.
Content Drives Business
Unlike Momo (NASDAQ:MOMO) or Baidu, iQiyi is driving content with an emphasis on Chinese values. Momo’s products faced a temporary block earlier this year when the government scrutinized its material.
So, iQiyi produces distinctive and original content that has an emphasis on the positive values of traditional Chinese culture and social themes. This lowers any odds of an unexpected block or ban from the Chinese government.
Looking into 2020, iQiyi will continue to work on improving the performance of its ad business. Brand ads will likely lag again so long as the macro uncertainties persist, but performance-based ads have the potential to offset the segment’s under-performance.
Valuation and Your Takeaway on IQ Stock
Investors may assume revenue grows by at least 20% annually over the next five years. In a 5-year DCF Revenue Exit model, a one-to-two times revenue exit multiple would imply that IQ stock is trading by 12% below its fair value.
At an optimistic level, iQiyi’s subscriber growth could sustain the 30% level for the next year or two. If its original content resonates more with new members, revenue growth will outpace my 20% annual estimate. That suggests iQiyi stock could trade at above the $20 level within a year.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.