China’s iQiyi (NASDAQ:IQ) video streaming service has had a roller-coaster 2020 already and it could get worse. IQ stock began a run in fall 2019 that culminated in an 11-month high close of $27.18 in February. From there, IQ felt the full effect of the novel coronavirus-triggered market sell-off.
Like many stocks, it has since begun to bounce back. However, iQiyi faces another threat that arose in April in the form of investor lawsuits accusing the company of fraud.
IQ is currently trading at $17.22 — right around its 2018 IPO price — but the growing number of legal filings are not good news.
The Need for User Growth
iQiyi is often compared to Netflix (NASDAQ:NFLX). InvestorPlace contributor Will Ashworth makes the point that a better comparison of its business model is actually a hybrid of Netflix and Roku (NASDAQ:ROKU). That’s because iQiyi has two revenue streams: membership subscription fees and advertising.
With the Chinese economy slowing, the company’s online advertising revenue has been slowing. In the last quarter, it dropped 15%. At the same time — like Netflix — iQiyi has been spending heavily on content.
Falling advertising revenue plus big expenditures on content make user growth even more critical if iQiyi is ever going to achieve profitability. In the latest quarter it posted an operating loss of $358 million on revenue of $1.1 billion.
Fraud Allegations
In that Q4 report, iQiyi said the number of subscribing users on its platform grew 22% year-over-year. However, serious allegations are now being raised about IQ’s numbers.
On April 7, Wolfpack Research published a report questioning iQiyi’s accounting. It also raised doubts about the company’s financial statements in prior years. Among the accusations:
“Our research shows us that iQiyi, Inc. was committing fraud well before its IPO in 2018 and has continued to do so ever since. Like so many other China-based companies who IPO with inflated numbers, IQ is unable to legitimately grow their business enough to true up their financial statements. We estimate IQ inflated its 2019 revenue by approximately RMB 8-13 billion, or 27%-44%.”
The Wolfpack report resulted in an immediate drop for IQ stock, although it quickly recovered. However, investor class action lawsuits are beginning to pile up.
iQiyi Responds
In the face of the damning allegations, iQiyi quickly released a statement refuting the Wolfpack claims that form the basis of the lawsuits:
“The company believes that the report contains numerous errors, unsubstantiated statements and misleading conclusions and interpretations regarding information relating to the company. The company emphasizes that it has always been and will remain committed to maintaining high standards of corporate governance and internal control, as well as transparent and timely disclosure in compliance with the applicable rules and regulations of the Securities and Exchange Commission and the Nasdaq Global Select Market.”
Bottom Line on iQiyi Stock
If you currently hold IQ stock in your portfolio, few analysts are suggesting selling it at this point. In fact, among the investment analysts surveyed by CNN Business, IQ narrowly holds a consensus buy recommendation.
If the company is able to successfully defend itself from the fraud accusations, 2020 may see IQ continue to recover. With their median 12-month price target of $24.94, the analysts in the CNN Money group are betting that will happen. However, whether the lawsuits are ultimately dismissed or end up going to court, the situation is going to take some time to play out. That means the remaining seven months of 2020 could continue to be a roller coaster for IQ investors.
If you’re in for the ride, don’t mind continued volatility, and have a degree of confidence that the fraud allegations won’t do further damage, iQiyi stock isn’t far off from its 2020 low. Now would be the time to jump on it. Otherwise, this latest round of drama is yet another reason to wait and see if iQiyi’s business model is sustainable in the long term.
As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.
