I’ve long been intrigued by the opportunity presented by iQiyi (NASDAQ:IQ) stock and for some time, I’ve been concerned about negative factors that are impacting IQ stock. iQiyi stock still sits over 50% below its all-time highs reached last June. And it’s likely that at least some of the decline has been caused by factors beyond the company’s control.
The trade war between the U.S. and China has pressured Chinese stocks. It’s also caused hurt the Chinese economy, lowering IQ’s advertising revenue. As I wrote in September, U.S. investors were dumping growth stocks of all kinds, and IQ stock was likely caught up in that trend.
It’s possible the pressure will return if the trade talks fall apart.
But if the market can just stay reasonably stable, iQiyi stock can rally meaningfully. The company is executing well. The problems keeping a lid on its advertising revenue will pass. And its valuation is much more reasonable than it seems. IQ stock looks poised to rise at some point: the big question is when.
The Case Against iQiyi Stock
On its face, IQ stock looks like a clear sell. The company isn’t profitable or close to being profitable. iQiyi stock is trading at over three times analysts’ average 2020 revenue estimate. iQiyi stock certainly is cheaper than its U.S. counterpart, Netflix (NASDAQ:NFLX). But iQiyi and Netflix are not as similar as some think, and many investors believe NFLX stock itself is overvalued.
IQ reported a lower than expected third-quarter per share loss than analysts, on average, expected, but a 70 cent per share loss is hardly cause for celebration. Its revenue was modestly below analysts’ average estimate.
And so, as Luke Lango detailed on this site, there’s a real fundamental case against iQiyi stock at the moment, even though it’s well off its highs. IQ is not a low-risk name, and it could easily drop.
But there’s good news for iQiyi stock.
Most notably, iQiyi posted strong user growth in Q3, with its paying subscriber base climbing an impressive 31% year-over-year. That increase was greater than that of Tencent Holdings’ (OTCMKTS:TCEHY) unit Tencent Video, whose subscriptions rose 22% over the same period. iQiyi’s subscriber base of 105.8 million now exceeds that of Tencent Video, which has 100.2 million paid users.
IQ’s advertising revenue was weak, declining 14%. That was one reason the company’s overall top line rose just 7%. But many Chinese companies’ digital ad businesses are weakening, with even iQiyi parent Baidu (NASDAQ:BIDU) struggling. Tencent Video’s total revenue actually declined year-over-year.
There are some competitive issues hitting digital ad sales, but for the most part China’s macroeconomic weakness is the main culprit. And that trend should ease at some point. Meanwhile, IQ’s growing subscriber base and higher viewership seem to position iQiyi well for the future.
The Case for IQ Stock
In that context, IQ stock isn’t as expensive as it looks. Including a modest amount of net debt, the company is valued at about $142 per subscriber. In contrast, the market is valuing Netflix’s subscribers at about $900 each.
Netflix’s subscribers are more valuable, given its higher monthly fees and, perhaps, the lower levels of macro risk in developed economies. But iQiyi may well have more growth ahead than Netflix, whose subscriber base increased 19% year-over-year in Q3.
It does seem like there’s at least some room for the valuation of IQ stock to expand. As it continues to grow and its ad revenues recover, the company should move toward profitability. The Chinese economy needs to cooperate, but for investors who believe that it will, I’ve believed for some time that IQ stock is the best play. I still believe that.
Will External Risks Pass?
That said, the sideways trading of IQ stock over the past six-plus months does make sense. External factors simply have not been favorable to the shares. Chinese stocks sold off in the fourth quarter of 2018 and struggled to recover for much of this year.
The fact that unprofitable names have recently fallen out of favor probably helped push IQ stock to an eight-month low in early October.
A rally off that low has stalled out — and, once again, external risks are rising.IQ stock’s resistance level is holding at $20. It may do so again unless or until the “risk-on” trade returns.
But once it does, there’s still room for the shares to break out. Their valuation, based on revenue and subscribers, remains reasonably favorable and well below 2018 levels. With Pinduoduo (NASDAQ:PDD) crumbling last month, iQiyi looks like one of the healthiest growth companies in China.
IQ still has problems. Its ad revenue may not resume growing any time soon. Alibaba’s Youku Toudu unit appears to be strengthening, with 47% year-over-year subscriber growth in Q3. Regulatory issues are a concern for the owners of IQ stock.
Still, IQ stock looks worth buying at some point. The question is when. I’ve worried for most of this year that the time isn’t quite right, and that looks to be the case again. iQiyi is doing what it needs to do to drive growth — but iQiyi stock won’t start climbing again without some outside help.
As of this writing, Vince Martin has no positions in any securities mentioned.