• IQ’s collaboration with BIDU is technologically, strategically and financially beneficial.
• The company can potentially benefit from a perceived rising tailwind in consumption of C-drama.
• IQ’s unique strength in long-form video contents suggest it does not directly compete with short-form video providers in the long run.
• The stock is undervalued, presenting a good investment opportunity.

Investment Thesis

The talks about Baidu (BIDU) selling iQiYi (NASDAQ:IQ) that started in 2022 is uncalled for based on current developments that saw Baidu officially establishing technological collaboration with IQ on AI. IQ is also the most formidable competitor to “Tencent Video” (owned by Tencent, Baidu’s rival) based on subscriber counts, implying a strategic incentive for Baidu to continue supporting IQ even if the latter is not doing well in the short term. Financially, IQ’s revenue contribution to Baidu is a significant 1/3 of Baidu’s core business revenue suggesting a financial incentive for Baidu to not sell IQ.

IQ faces significant competition from short-form video prompting the management to plan for the release of complementary features to mitigate such competition without losing focus on its core business in long-form video.

While IQ uses AI to enhance its content creation, so do its competitors. However, IQ appears to leverage AI to enhance its content generation “process” as opposed to its competitors that focus on the “technical” aspects. Hence, in the long run, IQ may not directly compete with its competitors (especially its short-form rivals) strategically in the long run.

The company’s subscriber revenue appears to be waning from a quarterly perspective but it is on a rising trend and even achieved new highs from an annual perspective. This suggests IQ’s strengths lie in attracting new paying customers and for loyal existing customers to stay subscribed to its service. To this end, I believe it can greatly benefit from a perceived rising trend in Chinese Drama (C-Drama) consumption.

The stock is very undervalued, presenting a good opportunity for investors looking for a deep value play.

Content and Technology Synergy With Baidu

Previously, Baidu was reportedly in talks to sell IQ back in 2022, when Baidu regards QI to be a “non-core asset”. Currently, not only was this potential sale not followed up after 2 years, but Baidu has recently strengthened its relationship with IQ in a recent strategic partnership in AI collaboration, contrary to the perception that the company is a non-core asset.

Generally, IQ has a rich amount of content and Baidu has AI technologies that feed on it:

1. iQiYi has more video-related data that Baidu’s AI engine can be trained on to make it more accurate.
2. When Baidu’s AI capability improves, iQiYi can make use of Baidu’s improved search results to improve users’ experience by providing targeted content that is more accurate than without Baidu’s AI

Such collaboration creates a synergistic relationship with IQ. Therefore, in my opinion, even if IQ is not doing well in the short term, Baidu is likely to continue supporting it to its long-term advantages.

Strategically, Baidu competes with Tencent, which owns Tencent Video. According to Statista’s data of subscriber counts, we can observe Tencent Video and iQiYi’s subscribers have consistently led other players in the market. Right now, iQiYi has led Tencent Video but its lead has been fluctuating since 2017.

With a market share rivalled only by Tencent Video in the Chinese OTT market, iQIYI is the most formidable competitor to Tencent Video, which is also a key competitor to Baidu. From this perspective, it is more likely for Baidu to continue supporting iQIYI to compete against a common rival effectively.

IQ’s revenue contribution to Baidu is relatively small but significant. According to Baidu’s Q3 2024 earnings call, revenue from IQ is about 1/3 that of Baidu’s core business:

Overall, Baidu is technologically, strategically and financially incentivized to support Baidu rather than selling it to other companies, possibly competitors.

Challenges from Short-Form Video Content

IQ needs to deal with significant challenges from short-form video content platforms in China, which Douyin and Kuaishou currently dominate in terms of monthly active users (“MAU”):

Douyin, the original Chinese version of TikTok developed by Bytedance, remained as the leader in China’s short-formed video scene. In September 2024, the app boasted to have 748 million active users across the country. Its closest rival, Kuaishou saw a rapid active user loss down to 471 million.

Both market leaders in the short-form video market boast MAUs above 470m. In contrast, while IQ is still one of the leaders in longer forms of online video apps, with an MAU of 413M, it trailed behind both the leaders of short-form video apps and its long-form rivals of Youku and Tencent video:

As of February 2024, Youku was the leading online video app in China with about 461 million monthly active users. Tencent Video trailed with almost 435 million active users while iQIYI secured its third place with around 413 million active users. Short video apps – one of the driving forces in China’s online video industry – were not included in this ranking.

Despite leading in subscriber counts over its competitors, IQ lags in terms of MAU. From the company’s earnings call, while the management plans to add features to benefit from the rising popularity in short form video. However, these are meant to complement its core long form content model rather than replace it.

The main iQIYI App will maintain its focus on long-form video content and subscription-based model, complemented by free mini and short dramas and advertising model.

With the potentially game-changing use of AI in its content creation, especially with its collaboration with Baidu, investors should consider whether IQ can effectively leapfrog over its rivals in MAU.

Leverage Of AI In Content Production

QI is not alone in the use of AI to improve productivity. So do its rivals of both long and short-form video:

• Tencent Video uses AI for a diverse range of use cases that revolve around technical enhancement, production and quality detection.
• Douyin is known for using AI for interactive features. Their AI-driven features like the “V Project” provide personalization by allowing users to create avatars that mirror their personalities, enhancing user interaction and engagement, and making the platform more dynamic.
• Kuaishou has developed its own AI models of “Kling” and “Kolor” for content creation. Kling is a text-to-video model comparable to OpenAI’s Sora while Kolor is a large-scale text-to-image AI generation model available on Hugging Face. This allows users to generate content more efficiently using advanced AI models.

Generally, IQ’s rivals use AI to improve the “technical” aspects of its content production and user engagements.

In contrast, IQ uses AI to improve its production “process” to produce high-quality, long-form content efficiently and enhance marketing efforts. According to this article by Jeffrey Towson, the production tasks that IQ used AI for appear to span across a broader spectrum of the overall workflow:

iQiYi appears to position itself to excel in generating content with more artistic depth as opposed to simply getting users’ short-term attention like what its competitors in the short-form video seem to be more interested in doing.

As mentioned in the article:

Keep in mind, iQIYI wants to create entertainment that is high quality. And, if possible, that sets cultural trends. They want to have the kind of impact shows like Game of Thrones and House of Cards had. They want the shows that everyone is talking about. And that people buy merchandise for. That requires a lot of advanced prediction, which AI should be very good at.

IQ is also the first to adopt Extended Reality (XR) in its full-length production:

iQIYI, an innovative market-leading online entertainment service in China, announced recently that parts of its drama series Fox Spirit Matchmaker (Yuehong Chapter) will involve Extended Reality (XR) Virtual Production, making the show China’s first drama series that adopts the kind of technology in its production.

In contrast, competitors like Tencent Video use a similar “mixed reality (XR)” mainly for the building of virtual worlds in the metaverse, rather than full-length movie/drama production:

Tencent previously bet heavily on the metaverse concept of virtual worlds. In June 2022, the company announced the official formation of XR unit, which was tasked with building up the extended reality business for Tencent including both software and hardware that time, the Reuters reported.

In my opinion, if IQ aspires to use AI to produce quality content with intangible depth in its movie/drama, it may not be directly competing with its competitors and hence presents a unique competitive advantage in the market.

Revenue Trend By Segments

From the company’s Q3 2024 earnings, revenue from the membership and advertising segments appears to be falling while content distribution seems to be the only segment experiencing a sustained increase in revenue:

However, from the company’s 2023 annual earnings, an opposite trend can be observed where membership revenue is the only segment that has experienced a consistently rising trend over the years:

The company’s business is still highly reliant on its membership revenue to drive its overall top line growth.

From the latest earnings call, the management provides 3 reasons why membership revenue dropped in the latest quarter:

First, as I previously mentioned, although we launched good quality titles in the quarter, there’s room for improvement in the supply of premium female-oriented and ancient costume dramas, which are especially appealing to members driven by hit titles.

Second, amid the current macro headwinds, users drawn to hit titles have grown more cautious in spending, and a broader selection of entertainment options is also seeking to capture their budget and attention.

Lastly, the high base effect from last year continued to play a part in our current figures.

For the second point, while macro headwinds can persist for an extended time, they are generally not permanent. For the last point, it is reasonable as we can observe how membership revenue surged from RMB 17M to RMB 20M in 2023.

The first point was about this earlier remark made in the same earnings call:

While we are proud of our performance in crime and reality drama genres, we recognize certain areas where we could improve. For example, the limited supply of key female-oriented costume dramas in the third quarter impacted hit title-driven members.

As consumer sentiments keep changing, I assumed the management has correctly identified “female-oriented and ancient costume dramas” as a forward-looking consumer demand based on reliable feedback received.

Investors should monitor whether the company can eventually act on this feedback and improve their content offerings. If the company is committed to such continuous improvements, the long-term trend of rising membership should persist.

Potential Emerging Tailwind Of C-Drama

A rising tide lifts all boats. Generally, in my opinion, IQ is in the business of producing and exporting Chinese pop culture products of C-drama. If there is a “rising tide” of pop culture in East Asia that tilts towards the consumption of C-drama, it will benefit all producers of C-drama, including iQiYi.

In East Asia, pop culture has evolved significantly since the 1970s. The exact area of popularity of each phase of its evolution can be subjective, but in my opinion, these are the key events:

1. The 1970s to 1980s saw the rapid rise of Cantopop originating in Hong Kong, creating A-list stars like the “Four Heavenly Kings” of “Jacky Cheung, Andy Lau, Leon Lai and Aaron Kwok”. Aside from their singing career, all of them have an extensive portfolio of highly sought-after Hong Kong drama/movie content at that time. These events benefitted companies like Television Broadcasts Limited (“TVB”) and Asia Television Limited (“ATV”), operating in the Hong Kong TV broadcasting industry.
2. In the 1990s to 2010s, Cantopop reached its peak and began to share the spotlight with Mandopop, with the later experiencing increasing popularity over Cantopop. Mandopop originated in Taiwan and experienced a breakthrough in popularity in the early 2000s with the release of teenage-oriented dramas like Meteor Garden. This drama is popular even in non-Chinese-speaking regions like the Philippines, benefitting Chinese Television System (“CTS”) of Taiwan. In music, Jay Chou became so popular that it received extensive coverage from Time magazine in 2003 and again in 2011 after he starred in his first Hollywood movie. Jay Chou’s success benefitted GHY, an entertainment company responsible for organizing Jay’s high profile events.
3. The 2010s to now saw the rise of K-pop, originating from South Korea, led by the musical groups BTS and Blackpink. In drama production, “Squid Game” released in 2021 became the most-watched Netflix drama of all time during at that time. According to a 2023 survey from Statista, Korean dramas (K-dramas) were popular in 41% (close to half) of the countries where the respondents came from. These events benefitted the “Big 4” entertainment companies in South Korea.

In all the points above, popular culture was concentrated within most of the “Four Asian Tiger” economies, except Singapore. Although multiracial Singapore enjoyed some mild success in the Chinese pop music scene in the 1980s, the success was short-lived and declined in the 1990s.

In my opinion, 2 common traits can be observed in the regions where popular culture flourished:

1. The economy is developing very fast, creating a consumer base with enough disposable income to splurge on discretionary entertainment expenditures.
2. The population is culturally homogeneous, allowing it to pool together enough talents to create a cohesive and appealing cultural output that resonates locally first, before exporting it internationally.

As described in the Wikipedia article cited earlier:

• “The Hong Kong economy was the first out of the four to undergo industrialization with the development of a textile industry in the 1950s.”
• “Taiwan and South Korea began to industrialize in the mid-1960s with heavy government involvement including initiatives and policies.”

The sequence of industrialization (resulting in economic development) correlates to the successful output of pop culture products, with Hong Kong first, followed by Taiwan and South Korea. Singapore also developed rapidly during the same period, but it is culturally diverse and thus faced unique challenges in creating a unified cultural identity that could be easily exported.

Right now, I observed China seems to have fulfilled the above 2 traits. First, the Chinese economy grew rapidly over the decades, shortly after joining the WTO, creating a consumer base with enough disposable income to spend on entertainment. Second, its population is relatively homogeneous, unlike Singapore. Recently China released the game of Black Myth: Wukong, an export of gaming pop culture built on Chinese mythology, which has become highly successful internationally. Can China replicate such success with dramas and movie content?

Assuming the Chinese entertainment industry is entering such a macro tailwind of flourishing Chinese pop culture, can iQiYi ride on such a tailwind to its advantage in C-drama export, potentially replacing the dominance of K-drama?

Why are K-dramas so popular? Can its popularity be replicated by iQiYi? According to Paste online magazine:

Korean content contains diverse genres and kinds of stories, but the romance-driven, female-centric “K-drama” format that has been successfully exported to countries around the world for decades has been integral to Hallyu, and it has been driven by women fans.

K-drama’s focus on a “female-centric” genre for K-drama is aligned with IQ’s management’s plan to focus on producing “premium female-oriented” dramas (as discussed earlier), suggesting the company is on the right track to replicate K-drama’s success, if the plan is executed well.

The management also have the intention to produce “ancient costume dramas”. These are dramas produced in the context of certain historical period, characterized by its feature of elaborate costumes and backdrop that are reflective of the era being depicted. In my opinion, the most successful Chinese pop cultural products built on this genre is the “Wuxia” genre, popularized by the late Louis Cha. I describe how it has the potential to benefit Chinese gaming products in another article:

Wuxia characters are often portrayed to possess exaggerated superhuman abilities through the practice of exotic/mystical Chinese martial arts and use these gifted abilities to embark on heroic adventures. The popularity of this genre of popular culture helps to spin off successful comics, movies, and other popular entertainment products among the Chinese community, including computer games.

If IQ decides to produce “female-oriented costume dramas” base on the same genre, it has a higher chance of succeeding since it is building on an existing cultural popularity.

Overall, iQiYi appears to enjoy several potential tailwinds in C-drama production:

• It operates in a market with a huge consumer base with disposable income, facilitating the consumption of discretionary pop culture products.
• The market is culturally homogeneous.
• The management made a strategic decision to focus on the production of content belonging to a genre that led to contemporary K-drama success.
• The focus on “ancient costume dramas” allows IQ to leverage on an existing culturally well known Wuxia genre.

Investors should observe whether such perceived potential tailwinds can play out eventually to the benefit of iQiYi.

Financial

We have observed IQ’s revenue trend from a quarterly perspective. This section will observe how the company performed from a longer-term, annual perspective up to the latest TTM. Seeking Alpha’s compilation of financial data over the last 10 years (available only to premium/pro users) is a great resource to begin with.

IQ has experienced high 2-digit growth in percentages on its top-line revenue in most years, averaging more than 24%. However, the company was loss-making for most years until recently when it achieved relatively small but positive net margins only in the last 2 annual periods.

The average/median loss in the long run is more than 20%. Investors should consider whether the company’s recent profits can be maintained and even increased further in the long run.

In my opinion, looking at the balance sheet, debt is significant but not overwhelming for the company.

While “total debt” makes up most of its “Total Current Liabilities” resulting in its working capital being negative on most years, the debt level is still less than 3 times its EBITDA on most years. Moreover, debt/EBITDA multiple has been on a downward trend since 2021.

Since 2015, the company’s net interest expenses on its debt is always low at less than 30% of its EBITDA. This is true even when its debt/EBITDA multiple peaked in 2019 and 2020.

Most of IQ’s short-term debt has been paid off or refinanced as of the last reported debt figure. At $7.6M, it is insignificant compared to its EBITDA of more than $1B, implying the company has effectively got its immediate short term debt under control.

IQ’s cash flow has been positive on most years. Most importantly, cash flow is positive in the last 2 annual periods. However, it does not seems to be increasing.

Overall, IQ’s financial profile is stable. Despite its significant debt volume, it has proven to be able to consistently service its debt obligations using less that 30% of its EBITDA. With a bottom line that has started to turn positive in recent years, investors should observe whether the company can reduce its debt further to achieve a positive working capital on its balance sheet. Ideally, the fee cash flow should also be on an increasing trend in the long run.

Valuation

Using the following information and other figures from Seeking Alpha, the intrinsic value (“IV”) is calculated using the DCF model:

• WACC of 6.26%.
• Starting FCF of an estimated $305.9M, as calculated from the last reported figures.
• As discussed previously, the company’s FCF appears to be flat over the last 10 years despite revenue growing significantly. Hence, I will assume the current trend persists meaning its future FCF growth in the next 5 years remains flat (0%).
• Thereafter, the company sustains a terminal growth rate of 3% which is within the “historical inflation rate (2–3%)”

The IV is $7.36 suggesting that even with a conservative assumption that there is no growth in FCF in the next five years, the current price of $2.15 implies it is deeply undervalued.

Previously, the price of IQ achieved this IV during the first quarter of 2023. Now, the current price appears to be trading near a visible support of $2.

With an IV that is deeply undervalued even with the assumption that the company has no growth for the next 5 years, this stock appears suitable for medium to short-term investors looking for a deep value play opportunity.

This buy scenario is similar to another deep value play opportunity of another stock that I have written on previously.

Risk

Operating in the Chinese market, IQ is exposed to the same regulatory risks as other Chinese stocks due to the government’s track record of implementing sweeping measures on targeted companies, forcing them to comply even if it means significantly hurting their bottom line for the benefit of the public’s welfare. This practice persisted until recently in 2023.

Investors should only invest in IQ if they are comfortable with this risk.

Conclusion

The continued long-term success of iQiYi’s business lies in its ability to produce high-quality long-form videos for its loyal paying subscribers.

“Quality” does not simply refer to technically advanced video graphics but also to the intangible depth behind the storyline of each video content. For example, can it emulate the success of low-budget but massively successful dramas like Squid Game from South Korea?

The management’s intentions to target the production of “premium female-oriented” dramas appear to be in the right direction, as discussed earlier. A perceived potential tailwind of a cultural tilt towards the consumption of C-drama might also play out to IQ’s advantage together with IQ’s leverage of AI in its production process.

The stock is currently deeply undervalued presenting a good opportunity for short to medium-term investors. Investors can buy the stock at the current price level and sell progressively as it approaches the price level near the IV which is around $7.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post iQIYI: Deeply Undervalued Gem With A Perceived Tailwind In C-Drama appeared first on Up2info.com.

• I am downgrading iQIYI Inc. stock to a hold rating due to mixed Q3 results and the need for progress in attracting short-attention span viewers.
• Q3 revenues fell 10% y/y to $1B, missing estimates by $20m, while non-GAAP EPADS beat estimates by 2 cents at $0.07.
• The company’s financial position is risky with $595m in cash and $1.2B in long-term debt, and operational performance is subpar.
• iQIYI’s focus on micro-dramas could improve margins and attract viewers, but execution must be perfect to capitalize on this growing trend.

Introduction

iQIYI, Inc. (NASDAQ:IQ) recently reported mixed Q3 results, in my opinion. Thus, I wanted to look at the numbers in more detail and give some comments on the outlook for the company and what could be a promising development that could turn the company’s luck around. I am downgrading to a hold rating until I see some good progress in attracting short-attention span viewers to its new micro-drama offerings, which should be a decent revenue generator if it can execute the plans.

Q3 Results

Revenues came in at $1B, -10% y/y, and missed estimates by $20m. Q3 non-GAAP EPADS came in at $0.07, which beat analysts’ estimates by 2 cents.

Digging a little deeper into the breakdown of revenues, membership services revenue came in at $622.1m. This was -13% y/y because of a lighter content slate. Advertising revenues were $190.5m, -20% y/y, due to the decrease in brand advertising. Other revenues were $103.8m, -8% y/y, while a saving grace to soften the blow was that content distribution came in at $116m, an increase of 52% y/y, driven by the increase in barter transactions.

Looking at the company’s profitability and efficiency metrics, operating income came in at $34m, which brings its operating margin to around 3% compared to 9% last year. Non-GAAP operating income was $52.5m, with a margin of 5% vs. 11% last year.

Regarding the company’s financial position, the company currently has around $595m in cash and equivalents against $1.2B in long-term debt. This position is a bit risky, in my opinion. The company’s operational performance is subpar. IQ’s operating income doesn’t cover the interest expense on long-term debt, so if it continues to underperform, that debt pile may become a decent risk. However, since the company does have almost $600m in cash and equivalents, it shouldn’t be an issue for now.

In summary, the results were mixed and more towards the bad end than good, in my view. The company is struggling to generate positive revenue growth and has lost quite a bit of profitability compared to last year. The macro headwinds are not doing any favors for the company and pose a real challenge right now, which may be out of the company’s hands.

Comments on the Outlook

The company has a lot of competition, which has been taking market share away from IQ for a while now. The rise of short-form video content through the likes of Vine, and now TikTok and other platforms that offer such a feature, is much easier to digest without committing too much time and effort in general. In my opinion, the company needs to adjust quickly to the ever-changing viewer, who seems to have a much shorter attention span, which may not be a negative. These generations are adept at multitasking and quickly processing information.

While long-form content is not going to go away any time soon, it is much harder to make such content profitably. Netflix (NFLX), being the pioneer, found a way to become very profitable over many years of improvements. It didn’t have as much competition before, which made it a little easier. For IQ, the company is up against so many alternatives in China, and as I mentioned, a short attention span means the content needs to be adjusted accordingly. Micro-dramas are one avenue that seems to be growing quite fast in popularity in China. Viewers binged on these micro-dramas that aren’t going to win any awards. They focus on tried-and-true ways to keep the viewer entertained through love affairs, rags-to-riches, and betrayal mini-dramas that last a few minutes and may have over 100 episodes to keep them entertained. Last year, Kuaishou said they had over 270m viewers watching micro-dramas, with over 94m paid viewers.

IQ, in the latest transcript, mentioned that the management had upgraded its iQIYI Lite App to focus on mini and short dramas with an advertising model. The main App will continue to focus on long-form content with a subscription-based model. This is a good development that tells me that the management is aware of the changing preferences of the younger generations and will not be falling far behind the competition. I think they are falling slightly behind the competition here. As I mentioned above, Kuaishou already had millions of people binging on micro-dramas back in ’23, so IQ is only getting into the trend now. It is going to take a while longer before it can reap the rewards, if at all. The micro-drama industry in China is estimated to be around $5.3B in 2023, so there is a lot of opportunity for growth in this segment if IQ can capitalize and execute on it.

With a further focus on micro-dramas, which is most likely its main revenue savior eventually, and being funded by advertising, I could see the company’s margins turning for the better. This will be once the company can properly market and produce this content to its vast audience of paid and free viewers. That remains to be seen, however.

What Am I doing with my position?

My small position is underwater right now by quite a bit; however, since it is quite a small position, I am not worried about further downside risk. I am not looking to currently add to my position, mainly because I would like to see how the new developments will do in the next quarter. I would like to see meaningful growth returning to its revenues, as well as its profitability needs to improve substantially. And I think short-form content will help it. Since it is a rather new development for the company, it needs to execute to perfection to attract viewers and advertisers and finally get out of the rut it’s been in for the last good while.

iQIYI, Inc. is currently down around 90% in the past 5 years, and if something doesn’t change operationally, the company is going to become a penny stock. Short-form content seems promising, but only time will tell if the company can deliver.

Therefore, I am downgrading the company to a hold rating and will revisit it in Q4 to see the progress.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of IQ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post iQIYI Q3: Nothing Impressive, But Short-Form Content Looks Promising appeared first on Up2info.com.

• iQIYI is trading at multiyear lows, with significant investments in AI and R&D expected to drive user growth and net sales.
• Baidu’s control and support, including increased user traffic, bolster IQ’s potential for future growth and profitability.
• Despite recent profitability and reduced debt, IQ remains undervalued compared to peers, with a promising EPS growth forecast for 2025-2027.
• Risks include potential declines in advertising revenue, content production challenges, and regulatory impacts on data privacy and international investments.

iQIYI, Inc. (NASDAQ:IQ) represents one of the largest streaming video platforms in China, and currently trades at multiyear lows. With a growing platform of users and most employees dedicated to research and development, IQ also revealed extensive use of artificial technologies to offer better video content as well as to enhance search capabilities. IQ does trade significantly undervalued as compared to other companies developing artificial technologies all over the world. In addition, there is the fact that Baidu, Inc. (BIDU), the largest search engine in China, signed agreements to provide user traffic to IQ. In sum, there are many reasons to believe that the stock could trade at better price marks in the future.

IQ

With operations in China, IQ offers video content online. In 2023, the company owned a total of 40k titles and a large number of diversified video content including drama series, variety shows, films, and others.

In the last quarterly report, the company noted that it has one of the largest subscribing member bases among all internet streaming services in mainland China. The company successfully developed diversified monetization models including membership services and online advertising services.

The Stock Is Trading At Multiyear Minimum Price Marks

If we do not look at the company’s financial statements, IQ’s stock price appears quite undervalued. When the IPO was executed many years ago, the stock traded at many times the current share price. We can buy shares today at not far from $2-3 per share.

I think that there are large stock buyers between $2 and $3 per share, which may explain why the stock price did not really fall below $2-$3. In my view, if the demand for the stock continues, and net income growth continues, we could see an increase in the stock price in the future.

In the last quarterly report, the company reported better than expected quarterly revenue. Besides, the EPS was not lower than expected. Goldman did cut its rating, which pushed the stock price down. However, many analysts think that the stock is a buy. The average price target is larger than the current price mark.

In My View, Artificial Intelligence Could Accelerate Net Sales Growth

The company uses AI technology for video content creation, purchase, production, tagging, distribution, monetization, and customer service. In the last annual report, IQ delivered significant information about the use of AI technology to enhance the platform. In this regard, investors could read the following lines from the last 20-F.

We have developed and put into use an integral set of technology infrastructures and tools, comprising of intelligent integrated production systems that improve digital workflow by integrating and streamlining the elements of video production; production business intelligence systems and integrated production tool sets that empower content producers with AI-powered decision-making, and other tools that support the facilitation of the content production process. Source: 20-F.

In my view, IQ will most likely learn a lot more about its customers in the coming years thanks to AI. My main thesis about the company is that the new learning from AI will most likely accelerate viewership and monetization, and will most likely bring net sales growth generation. With other companies using AI in the United States trading at high valuations, I do not think many investors did take a look at IQ.

I Think That Investments In Research And Development Could Enhance Net Income Growth

The company continues to make significant investments in research and development. These investments are expected to enhance user profiling and content recommendation. The company also uses AI Radar and Watch Me Only to support real-time recognition besides searching information from video images. As a result, clients can search content specifically from certain artists, or do better searches. In my view, these features will most likely accelerate subscribers, and bring net sales growth. The company gave the following information about R&D expenses in the last 20-F:

In the years ended December 31, 2021, 2022 and 2023, our research and development expenditures, including share-based compensation expenses for research and development staff, were RMB2,794.9 million, RMB1,899.2 million and RMB1,766.6 million (US$248.8 million), respectively, representing 9.1%,6.5% and 5.5% of our total revenues for the years ended December 31, 2021, 2022 and 2023, respectively. Source: 20-F

I reviewed the total number of employees and their activities. According to the last annual report, a significant number of employees work in research and development. There are more employees doing R&D than employees doing marketing or content production. Take a look at the following table from the annual report.

It means that the company is really betting on technological developments inside IQ. Given that the company is really making a lot of efforts to provide quality video content and technological innovations, I expect net sales growth in the future.

Baidu Controls IQ, And Accepted To Increase IQ’s User Traffic

I think that it is interesting to review the list of shareholders and the voting power. The company reports two classes of shares. Class B shares offer more voting power per share than class A shares do. In this regard, the following lines are from the last 20-F.

Each holder of our Class B ordinary shares is entitled to ten votes per Class B ordinary share. Our Class B ordinary shares are convertible at any time by the holder into Class A ordinary shares on a share-for-share basis. Source: 20-F

There is one shareholder, Baidu, which owns close to 89% of the total voting power. I am not at all concerned about this fact. Baidu is also a technological company, which means that it understands well what IQ does. In my view, it will most likely elect clever executives to the Board of Directors, and make clever decisions about the future of IQ. Baidu and IQ signed agreements with regard to future developments. Besides, Baidu agreed to increase IQ’s user traffic, which appears quite ideal. In this regard, I would read the following words.

We and Baidu agree to cross-sell our respective advertising services, and Baidu agrees to grant us priority to advertise on its platform; we and Baidu agree to leverage our respective services to increase user traffic; and we and Baidu agree to allow our respective registered users and content providers to log onto each other’s platforms. Source: 20-F

Undervalued, And 2025 EPS Expectations Stand At Close To 48% Y/Y

I do not think investors successfully reacted to the recent increase in profitability seen in the last two years. Both the net income and the free cash flow increased recently after many years of negative results. Unlevered free cash flow in the last three years stood at more than $2 billion, and appears to be accelerating. In my view, investors running financial models about the company will most likely discover that the company is substantially undervalued.

With new cash accumulating, the company gradually reduced its total amount of debt, so net debt appears quite under control right now. As shown in the last quarterly report, in August 2024 the company repurchased its convertible senior notes due 2026.

In August 2024, the Company completed the repurchase right offer for its 4% convertible senior notes due 2026 (the “Notes”). An aggregate principal amount of US$395.5 million of the Notes were validly surrendered and repurchased with an aggregate repurchase price (including the aggregate principal amount of the Notes plus accrued and unpaid interest) of US$397.5 million. Source: Quarterly Report

It is also worth noting that the total amount of equity also increased in the last three years. The book value per share is currently not far from the current share price. Companies in the United States running artificial technology never trade close to the book value per share.

Currently, the company’s PE GAAP FWD ratio is close to 13x, and the PE GAAP TTM stands at 8x. Besides, the company’s EV/ FWD EBITDA appears to be close to 1x-2x. In sum, there are many variables indicating that the company is quite undervalued.

In my view, as soon as more analysts take a look at the EPS expectations for 2025, 2026, and 2027 the stock price could trend north. I obtained the following figures from Seeking Alpha:

There Are Some Risks

The company signs agreements with advertising agencies from China. These agencies receive rebates based on the volume of business that they bring to IQ. According to the last annual report, IQ noted that the number of advertising agencies in China decreased as a result of a consolidation phase. In my opinion, lower advertising budgets, lower demand, or work from advertising agencies could lower the amount of money that IQ collects. If advertising revenue declines, IQ could deliver lower EPS growth and FCF growth. In the worst-case scenario, we could see a decline in the stock price.

The company’s business model mainly depends on the ability to produce good content. In this regard, it is necessary to have qualified personnel. In the last decade, IQ hired a significant number of employees, and the number of subscribers increased. In sum, I think that IQ’s talent acquisition abilities are beneficial. With that being said, in the future, the company may not be able to provide high-quality original content offerings for many reasons. Artists may decide not to work for IQ, or other platforms could pay more than IQ. As a result, the number of subscribers and visitors could lower. In the worst-case scenario, net income growth could be lower.

The company’s business is subject to new regulations with regard to information security, privacy, and data protection. If new laws in China damage the company’s freedom to sell, transmit, and exploit information from millions of clients, I think that the company’s net income growth could be lower. If a sufficient number of analysts write detrimental reviews about the company, and expectations about future EPS decline, the stock price could be lower.

Among the new laws, which could damage the company’s revenue line, there is the PRC Cybersecurity Law. The law requires that network operators collect and use personal information. If the company fails to respect such new regulations, the fines could affect the company’s net income. IQ offered substantial information about these matters in the last annual report.

The PRC Cybersecurity Law, which took effect in June 2017, created China’s first national-level data protection framework for “network operators.” It is relatively new and subject to interpretations by the regulator. It requires, among other things, that network operators take security measures to protect the network from unauthorized interference, damage, and unauthorized access, and prevent data from being divulged, stolen, or tampered with. Source: 20-F

The company may also suffer substantially if the ADSs cannot be sold in the United States because of the Holding Foreign Companies Accountable Act. As a result, I think that the total amount of cash received from international investors could be lower, which may lead to lower cash per share and book value per share. Besides, IQ may not be able to invest in research and development, and future net sales growth expectations could be lower.

My Opinion

IQ is currently trading at multiyear lows after delivering positive unlevered free cash flow for some years. Besides, the company continues to invest substantially in research and development, and artificial intelligence technologies continue to enhance video content and search capabilities. The fact that Baidu controls IQ and appears to help the company increase its user traffic. I do not see what could go wrong in terms of traffic generation and user growth. Baidu is like Google in China. In my opinion, if free cash flow growth continues, and a sufficient number of investors study the company’s financials, the stock price could trend back up. The recent reduction in the total amount of debt, recent equity growth, and the price/book value per share indicate that IQ appears to be significantly undervalued.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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• iQIYI, Inc.’s Q2 2024 results met the market’s expectations, as the company’s top line and bottom line were pretty close to the respective consensus forecasts.
• The company is expected to report negative revenue growth and operating margin contraction in Q3 2024, similar to how it performed for the second quarter.
• A lack of surprises relating to iQIYI’s actual second-quarter performance and the company’s Q3 financial outlook implies that a Hold rating for the stock is justified.

iQIYI, Inc. (NASDAQ:IQ) shares are still rated as a Hold. The company’s Q2 headline numbers were in line with the consensus estimates. Looking forward, I don’t expect iQIYI’s third quarter results to throw up any significant surprises. As such, it is reasonable that I retain a Neutral view for IQ.

My prior update, written on June 4, 2024, looked at the company’s full-year fiscal 2024 prospects. IQ’s actual second quarter results and expected Q3 performance are in the spotlight for the current article.

Q2 Performance Was Consistent With What Market Had Anticipated

The company’s key Q2 2024 financial metrics revealed in its earnings announcement released last week were aligned with the sell-side analysts’ prior expectations.

IQ’s actual Q2 2024 revenue of RMB 7,438.8 million was marginally or +0.3% above the market’s consensus top-line projection of RMB 7,415.9 million. Its non-GAAP adjusted earnings per share or EPS of RMB 0.25 for the second quarter was the same as what the sell side had predicted previously. I obtained the consensus financial estimates for iQIYI from S&P Capital IQ.

The top line (in RMB terms) for iQIYI contracted by -4.7% YoY in Q2 2024, which is similar to the -5.0% YoY revenue decline that the company suffered for Q1 2024.

Competitive pressures have continued to weigh on IQ’s most recent quarterly top-line performance. In my previous June 4, 2024, article, I cautioned that iQIYI’s “long-form video streaming business is facing competition from short-form video competitors.” At its Q2 earnings briefing, IQ noted the competition posed by “other forms of entertainment” like “short-form video.” The company also highlighted the “competition within the long-form video sector” at the recent quarterly analyst call, with the acknowledgement that “certain titles did not meet our high expectations.”

IQ’s normalized EPS declined by -59.0% YoY for the second quarter of this year, which was in line with expectations as mentioned above. The company’s actual Q2 2024 operating margin was 4.6%, which was lower than its actual Q1 2024 and Q2 2023 operating margins of 11.9% and 7.8%, respectively.

The company managed its costs pretty well for the recent quarter, as its aggregate operating expenses declined by -1.3% YoY to RMB 7,096.7 million in Q2 2024. IQ’s operating profit decreased by -RMB 268.3 million YoY in the second quarter of 2024, which is not that far from the -RMB 363.5 million YoY revenue decline in the latest quarter. As such, iQIYI’s actual Q2 2024 bottom-line performance would have been even worse and missed the analysts’ expectations, if it hadn’t maintained a tight grip on expenses.

To sum things up, iQIYI’s recent second quarter results were poor, but this was something that the market had already expected.

A Turnaround Is Unlikely To Happen In Third Quarter

IQ is expected to announce the company’s Q3 2024 financial results in late November this year, judging by its past results release dates. I believe that there won’t be any positive surprises emerging from iQIYI’s next quarterly financial disclosure.

The company revealed at its latest analyst briefing that it “experienced some fluctuation in our drama market share” for the second quarter, but it stressed that it took back “the leading spot” in July. At the Q2 earnings call, iQIYI also explained that there are “fluctuations” in its membership numbers resulting from “members who are attracted by new and popular content.”

There are two factors to consider here.

Firstly, time is needed for the changes in IQ’s share of drama viewership to be reflected in the company’s revenue. A popular drama might not immediately translate into new member sign-ups, and there are typically free one-month trials for new subscriptions. Therefore, IQ’s Q3 top-line performance could be largely influenced by the “fluctuation in our drama market share” for Q2, rather than the company’s return to the top position in drama viewership for July or the early part of Q3.

Secondly, there is no assurance that iQIYI’s drama viewership lead can be sustained in August and September. Chinese consumers seem to have no issues switching among streaming video service providers depending on new hit shows, as per iQIYI’s observation regarding “members who are attracted by new and popular content.”

This explains why the sell-side analysts are projecting a more severe top-line contraction (in local currency terms) of -9.0% YoY for IQ in Q3 2024. (source: S&P Capital IQ data).

Regarding future profitability, my opinion is that iQIYI won’t step up cost-cutting efforts or raise subscription pricing in the short term. Based on consensus data taken from S&P Capital IQ, the market is forecasting that IQ’s operating margin will contract from 4.6% in Q2 2024 to 2.8% for the third quarter.

IQ mentioned at the company’s Q2 2024 earnings briefing that its “focus will be on expanding the scale of our membership” in “the near future” which is in contrast with the “ultimate goal” to “maximize membership revenue” for the long run.

A review of iQIYI’s management comments suggests that the company will continue to invest in initiatives to expand its membership base in the short term, if it comes at the expense of lower revenue and profits. An example will be the potential discounting of IQ’s membership subscription pricing to entice new members, which might be negative for its top line and earnings. Furthermore, the company is unlikely to reduce marketing efforts in a big way, with membership base expansion remaining a priority.

Final Thoughts

iQIYI, Inc. shares are reasonably valued and there is an absence of near-term catalysts pertaining to a potential improvement in financial performance.

IQ’s forward P/E and projected bottom-line expansion rate are both at the high-single digit range, and this supports my view that iQIYI is trading at a fair valuation. Specifically, the stock’s consensus current fiscal year normalized P/E multiple and consensus FY 2023-2026 normalized EPS CAGR estimate are 9.6 times and +7.4%, respectively according to S&P Capital IQ data.

Regarding the company’s outlook, IQ is unlikely to witness a meaningful turnaround in its financial performance for Q3 2024 as explained in the previous section.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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• iQIYI’s revenue could grow at a more moderate pace in 2024, considering its Q1 top line performance, a focus on the long term, and competition from short-form videos.
• IQ’s first quarter operating margin beat expectations, and there is potential for further profitability improvement driven by marketing expense optimization and content cost reduction.
• I have chosen to downgrade my rating for iQIYI stock to a Hold, as I view the company’s outlook as mixed.

Elevator Pitch

My rating for iQIYI, Inc. (NASDAQ:IQ) stock is a Hold. I previously touched on iQIYI’s pricing strategy and financing activities in my February 5, 2023 article.

This latest write-up is focused on IQ’s future financial performance. The company’s 2024 outlook is mixed, as there are expectations of both revenue growth deceleration and operating margin expansion. Therefore, my decision is to revise my rating for IQ from a Buy to a Hold.

Top Line Growth Deceleration

In the past one month, the sell-side’s consensus FY 2024 top line estimate for iQIYI was cut by -4% from RMB34,057 million to RMB32,807 million as per S&P Capital IQ data. This implies that IQ’s revenue expansion rate is projected to moderate from +10% YoY in the previous year to +3% YoY for the current year.

The company’s top line growth prospects in the short term are likely to be weak as per the analysts’ forecasts, taking into account a number of factors.

Firstly, iQIYI’s most recent Q1 2024 results had unfavorable read-throughs for the company’s top line outlook.

Revenue for IQ decreased by -5% YoY to RMB7,927 million in the first quarter of 2024, and this represented a modest +1% beat (source: S&P Capital IQ). As a comparison, iQIYI had delivered positive sales growth rates of +15% YoY and +2% YoY for Q1 2023 and Q4 2023, respectively. It is fair to say that the company’s recent revenue growth momentum is weak.

Secondly, the latest changes to IQ’s disclosures indicate that the company will place a greater emphasis on success for the long run that could come at the expense of short-term underperformance.

At its Q1 2024 analyst briefing in mid-May, iQIYI revealed that the company will “no longer” report its “subscriber (count) and ARM (Average Revenue Per Member) data.”

IQ explained at its recent quarterly earnings call that “membership revenue” will be the “core indicator” going forward, as the company’s target is to “maximize long-term (my emphasis) membership revenue.” The company also noted at the first quarter results briefing that “extending the lifespan of each membership” is as important as the other top line growth engines like increasing ARM and expanding the subscriber base.

In other words, iQIYI is likely to be willing to accept lower ARM and slower subscriber growth (and a more modest pace of revenue increase) for the near term, if it means attracting and retaining loyal and higher-value subscribers for longer.

Thirdly, the company’s long-form video streaming business is facing competition from short-form video competitors.

Caixin Global published a commentary piece on December 7, 2023 noting that “mini dramas” rolled out by “short-video platforms” have grabbed “users’ attention” away from “long-video platforms” in China. An earlier November 2023 China Daily news article also highlighted that the “Chinese short video users” had already exceeded a billion in 2022. According to the early-December 2023 Caixin Global news report, the total GMV (Gross Merchandise Value) for short-form videos in China is estimated to have increased by +160% in the prior year, which is a reflection of their growing popularity.

In summary, IQ’s revenue outlook for the current year is weak. In the next section, I evaluate the company’s future profitability.

Profit Margin Improvement

IQ’s normalized operating profit margin expanded by +190 basis points QoQ and +160 basis points YoY to 11.9% for Q1 2024. The company’s actual first quarter non-GAAP adjusted operating margin was +260 basis points higher than the market’s consensus forecast of 9.3% (source: S&P Capital IQ). Moving ahead, the analysts see iQIYI’s normalized operating margin improving from 9.4% last year to 12.7% this year.

Strict cost control and the utilization of AI are most probably going to be the major profitability enhancement drivers for iQIYI.

The company’s SG&A (Selling, General & Administrative) costs decreased by -17% YoY from RMB1,106 million in the first quarter of 2023 to RMB922 million for the most recent quarter. This also meant that IQ’s SG&A costs-to-revenue ratio declined by -1.6 percentage points YoY to 11.6% in Q1 2024. “Disciplined marketing spending” was credited as the main reason for iQIYI’s lower SG&A expenses in its Q1 2024 earnings press release.

Separately, iQIYI stressed at the latest Q1 2024 analyst call that the company “has meaningfully enhanced the industrialization of content production and operation”, even though it is at the “initial stages of fully unleashing the potential of generative AI.” As a reference, IQ’s content costs-to-sales ratio decreased from 53% for both Q2 2023 and Q3 2023 to 50% and 48% for Q1 2024 and Q4 2023, respectively. As such, the company’s content costs as a proportion of revenue is likely to continue declining in the future, as it exploits AI for content production in a more significant manner.

In a nutshell, I expect IQ’s profitability to improve going forward with the company’s emphasis on expense management and the presence of AI-related content cost optimization drivers.

Concluding Thoughts

IQ deserves to be rated as a Hold. The company’s prospects in terms of top line expansion and profitability improvement are mixed.

In terms of valuations, iQIYI currently trades at an undemanding consensus next twelve months’ normalized P/E of 8.6 times as per S&P Capital IQ, which I deem to be appropriate. IQ’s modest P/E valuation multiple is a reflection of the company’s lackluster top line growth in absolute and historical terms. The consensus FY 2023-2026 revenue CAGR estimate in RMB terms for iQIYI is +4.5% (source: S&P Capital IQ), or much lower than the company’s historical FY 2017-2023 top line CAGR of +10.6%.

Although iQIYI’s operating profitability outlook is good, IQ needs to record a faster pace of top line expansion at a high-single digit percentage to justify a superior P/E ratio. As such, the stock’s valuations are fair for now and iQIYI warrants a Hold rating.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

Asia Value & Moat Stocks is a research service for value investors seeking Asia-listed stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like “Magic Formula” stocks, high-quality businesses, hidden champions and wide moat compounders). Sign up here to get started today!

The post iQIYI: Anticipating Slower Growth And Profitability Improvement (Rating Downgrade) appeared first on Up2info.com.

• iQIYI is trading at depressed levels compared to historically.
• Q4 results showed flat quarterly revenue but impressive annual growth, with membership services and advertising revenue contributing to overall growth.
• iQIYI is leveraging AI technology to improve efficiency and content production, and its strong library of original content is driving viewer engagement and market share.

Spun-off by Baidu (BIDU) in 2018, iQIYI (NASDAQ:IQ) has faced a precipitous decline in share price from an over $40 peak in 2018 to around $4 as of late. iQIYI stands out amongst competitors/peers as having achieved so far sustained profitability, but this does not seem to be reflected in current prices with the stock plummeting by similar percentages. In relation to these competitors iQIYI stacks up favourably, and although there are some risks to consider as well as questionable Q4 results, these are outweighed by the inherent strength of the company’s library and potential catalysts including effective deployment of AI to increase efficiency.

Q4 And Annual Results

In Q4, relatively flat quarterly results were contrasted with impressive annual ones. Annually for 2023, revenue grew 10%, operating profit grew 68% and net profit grew 121%. Q4 revenue meanwhile only increased by 1% YoY, while average daily total subscriber count actually fell to 100.3 million from 107.5 million the previous quarter. Offsetting this appears to be Average Revenue per Member which grew 13% annually, with the subscriber mix improving and more annual plans. These numbers are a bit worrying if they extrapolate further, it could be an indication membership will plateau and iQIYI are currently compensating with gains in ARM.

Membership services for 2023, which make up the majority of revenue, grew 15% annually to over RMB 20 billion, while advertising grew by 17%. Advertising revenue grew 6% in Q4 YoY which management attributed to a recovery in the health, communications and food and beverage sectors, as well as generative AI.

AI Developments and Efficiency Gains

There is a vast array of potential applications for AI in the entertainment industry and currently iQIYI is wasting no time in deploying them. Generative AI is being used to improve ad creation, mass production of marketing materials and generation of plot summaries. The efficiency of content production is also being improved by the “iQIYI Content Production Management System” which records the production process, this is backed up by results, with content cost having fallen by 5% annually for Q4 and the content related cost ratio having declined by 12% annually. Further integration of and investment into AI to speed up production seems like a good catalyst for the stock. However, the longer term impact of AI on this stock and many others is more ambiguous, video generating models now exist and plausibly will grow more sophisticated in the future, so it is a matter of monitoring the technology and how the company adapts.

Strong Content Library

Producing original content is critical to retain subscriptions and market share, and iQIYI has been producing an increasing percentage of originals, which now account for 65% of drama releases. Tim Gong comments on original content below.

Tim Gong, Q4 earnings:

Original programming remains the cornerstone of our content strategy and a key revenue driver. We have made remarkable advancements in the quality of our original productions. In 2023, original content contributed 80% of the total revenue from key new dramas during the new-release period. And that’s not all. For 7 straight quarters, over half of our revenue for new key dramas has come from original titles.

Using the company’s popularity index, a proxy for viewership and engagement, the figures for content are improving with 71% more titles exceeding a score of 9,000 on the index as compared to 2021. Viewership figures also support this, with a 47% share in the Chinese online movie streaming market and the company broadcasting 7 of the top 10 most viewed new dramas.

Additionally, animation is a growth area both now and potentially for the future. 2023 saw a 90% increase for revenue from animation, while iQIYI also focused on expanding their original animation content by doubling the number of original titles.

International Market

Expansion into the international market, likely specifically the South East Asian and other Asian markets will be a key area to target for more growth. While there is no revenue breakdown by region released by iQIYI, growth for Q4 in many countries exceeded domestic figures as addressed below.

Tim Gong:

In Q4, membership revenue and ad revenue both recorded double-digit annual growth, driven by the growing popularity of premium content among users and advertisers. Membership revenue increased by over 80% in Japan, Hong Kong and the UK, and over 50% in Mexico and South Korea. Ad revenue grew 20% annually and 49% sequentially.

Southeast Asia is also a key overseas market the company is expanding into. In an announcement in December iQIYI announced 280 more Chinese language dramas, films and variety shows and over 35 original productions from Southeast Asia. A bit more transparency into the relative size of these markets and revenue figures would be desirable, to properly assess the opportunities internationally.

Valuation

Charting the trailing EV/EBITDA alongside some similar companies, the company is well below Netflix’s (NFLX) comparatively lofty multiple but above Huya (HUYA). The forward EV/EBITDA is even lower at 2.35, over 70% below the sector median. Perfect comparisons here are difficult to find because some of the competition are segments of much larger companies like Youku, part of Baba (BABA) or Tencent Video, part of Tencent (OTCPK:TCEHY). IQIYI’s forward P/E ratio is 9.89, which is over 40% below the sector median of 16.97, a significant difference.

Wall Street analysts have a Buy rating for the company and are as positive as they have been in the last five years, a positive trend despite the general position of the market being pessimistic on Chinese stocks recently.

Risks

General China related risk is of course present, however it seems likely that at this point many investors who find the risk too high have already closed their positions. For this particular stock it does not seem particularly at risk from international geopolitics, as the company is broadly serving a domestic market, and does seemingly should not have any relevance to defence or related concerns. The Chinese regulatory landscape is perhaps more concerning. In 2021 the country passed data security and personal information laws governing how companies manage data. While there does not appear to be any recent news that directly affects IQ, the entire framework is quite murky regarding what standards will be applied to who and how rigid enforcement will be.

Another problem is the company’s debt. The company has a current ratio of 0.57, which is low even taking into account some peers have relatively low ratios near one. Interest coverage ratio is at 2.64 which is fine but borderline. Given profitability being a relatively recent development for the company there is an argument to be made this may be a problem if it proves hard to sustain.

Conclusion

iQIYI is a compelling prospect when considering various strengths that make it standout against other beaten down Chinese stocks, including a recent history of profitability, a strong originals library of content and catalysts such as AI tools which are helping drive efficiency. There are however some drawbacks, specifically China related factors, the current ratio and potentially AI disruption down the road, something that is hard to forecast. Despite these, at this price there is room for upside here which is why I have a position.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of IQ, BABA, BIDU either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I am not a financial adviser and this is not financial advice. This article is intended for informational purposes only and reflects my personal opinions only. You should always make investment decisions based upon your individual financial situation and personal research. Please consult a licensed investment adviser before making any investment decisions.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post iQIYI: Room For Upside appeared first on Up2info.com.

• iQIYI’s revenue grew, driven by double-digit growth in income from paid memberships and online advertising services.
• Despite the upbeat annual figures, IQ’s fourth quarter results were more mixed and raised concerns over future challenges it could face amid growing consumer caution in China.
• The stock is down 16.6% in the last three months and has lost nearly half its value over the last year.

iQIYI Inc. (NASDAQ:IQ), one of China’s leading long-form video streaming platforms, posted its first annual profit last year, reporting net income of 1.9 billion yuan ($271 million) in 2023, reversing a 136.2 million loss the previous year, according to its latest earnings announcement on Wednesday.

The company attributed the move into the black to a shift in its priorities in 2022, when it began downsizing its non-core businesses and investing further in premium original content. The 2022 commitment to original content helped the company boost its financial performance by drawing in more paying customers.

“Building on the momentum of an iconic turnaround in 2022, 2023 stood as our best-performing year in our corporate history,” said iQIYI founder and CEO Tim Gong. “Key financial metrics, including total revenues, operating and net income and cash flows, all hit historical highs.”

The company’s revenue grew 10% to 31.9 billion yuan for the year, driven by double-digit growth in income from paid memberships and online advertising services.

Full-year revenue from its membership services rose 15% to 20.3 billion yuan, driven by growth in its average revenue per member (ARM) and subscriber base. Its ARM has achieved sequential growth for five consecutive quarters to a record high of 15.98 yuan per month in the fourth quarter, up 13% on an annual basis.

Online advertising revenue rose 17% to 6.2 billion yuan last year, while content distribution revenue fell 4% to 2.5 billion yuan as a result of fewer barter transactions.

The company’s full year non-GAAP operating profit was 3.6 billion yuan, up 68% over the prior year. In addition to recording its first annual net profit, the company’s full-year cash flow of 3.3 billion yuan marked its first time being cash flow positive on that basis.

Despite the upbeat annual figures, iQIYI’s fourth quarter results, released concurrently with the annual results, were more mixed and raised concerns over future challenges it could face amid growing consumer caution in China.

Fourth quarter revenue rose just 1% year-on-year to 7.7 billion yuan, and membership services revenue was also only up 1%. The average daily number of total subscribing members for the quarter was 100.3 million, down from 111.6 million a year earlier and also down from 107.5 million in the previous quarter.

The company said it will offer more differentiated products tailored to different user cohorts, optimize content scheduling and enhance its loyalty program to achieve higher user retention. It will focus on having more quality premium titles that bring higher monetization.

iQIYI’s shares were unchanged in Wednesday trade after its latest report came out. The stock is down 16.6% in the last three months and has lost nearly half its value over the last year.

iQIYI was founded in 2010 as a video website owned by Chinese internet company Baidu (BIDU) and was once dubbed “the Netflix in China.” China’s video streaming market is intensely competitive, and the company faces strong competition from key rivals like Alibaba’s Youku (BABA) and Tencent Video (OTCPK:TCEHY).

Disclosure: None

Original Post

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

The post iQIYI Growth Stalls In Fourth Quarter, As It Posts First Annual Profit appeared first on Up2info.com.

• Shares of iQIYI have experienced a significant decline since the publishing of my bearish articles in 2020 and 2021.
• However, the company has recently achieved four consecutive quarters of positive free cash flow and has turned profitable due to revenue growth and expense control.
• In the meantime, the stock appears attractively priced.
• Thus, my view on the stock has turned from bearish to bullish.

The first time I shared an article on iQIYI (NASDAQ:IQ) was all the way back in April 2020, supporting the view that the company’s unattainable profitability was poised to deteriorate shareholder value.

This was followed by two more bearish articles in August and December of the same year and one more in April 2021, each reiterating my view and building on my bearish stance on the stock.

I am listing them below, just for the record, in case anyone wants to go back and read my thoughts.

• April 2020: iQIYI: Unattainable Profitability Deteriorates Shareholder Value
• August 2020: iQIYI: Consistent Shareholder-Value Crumbling Is Set To Continue
• December 2020: iQIYI: Shareholder Value Going Straight Down The Drain
• April 2021: iQIYI: The Shareholder Value Deterioration Story Continues

Since each article was published, the stock has declined by 71.7%, 74.7%, 71.5%, and 71.7%, respectively.

As you can see in the graph, iQIYI proceeded to post massive negative free cash flows in the quarters following my articles. In turn, management kept diluting shareholders as its money-losing operations meant it constantly needed more cash.

However, this trend has reversed lately. As the same graph above illustrates, iQIYI has now posted four consecutive quarters of positive free cash flow. In fact, free cash flow in each of the past four quarters has exceeded $100 million.

Although iQIYI has begun to generate positive cash flow, the stock’s sentiment has not yet reflected this positive shift. The investment landscape has transformed from that of an unprofitable company with an expensive stock – which prompted my previous bearish stance – to that of a profitable company with an attractively priced stock, thereby driving my current bullish stance.

But let’s take a step back to review how the company turned profitable and why its bottom line is likely to remain green moving forward.

How Did IQ Turn Profitable? – And Why It’s Going To Last

iQIYI’s leap into profitability can be credited to an impressive resurgence in revenue growth and meaningful expense control. Let’s take a look at both factors.

Revenue Growth Resumes

To contextualize this turnaround, iQIYI grappled with losses in nearly every quarter from the fourth quarter of 2016 through the third quarter of 2022, with only two notable exceptions—one being a unique, non-recurring gain in the fourth quarter of 2017 tied to IPO-related gains.

In the face of these hardships, iQIYI experienced a deceleration in revenue growth, witnessing a dip in its last-12-month (LTM) revenue growth from a mighty 111% in the fourth quarter of 2016 to a worrisome -6% in the third quarter of 2022. During this period, the company was witnessing a gradual erosion in its performance quarter after quarter.

However, in recent quarters, iQIYI orchestrated a notable reversal, achieving four consecutive quarters of revenue growth. As the graph above illustrates, the company’s LTM revenue growth as of its most recent quarterly report (Q3) stood at an impressive 10.3%. This marks a notable upswing from the preceding year’s -6%.

The company’s third-quarter results highlighted that the resurgence in top-line growth is being propelled by an expanding membership base, complemented by an encouraging uptrend in revenues per membership.

In particular, iQIYI posted a 7% uptick in revenue for the quarter, reaching $1.1 billion. This surge was fueled by a 6.4% surge in average daily subscribers to 107.5 million and an 11.8% increase in the monthly average revenue per membership to RMB15.54 ($2.19).

iQIYI’s third quarter performance received an added boost from Online Advertising Services revenues, totaling an impressive $229.5 million—a 34% year-over-year surge attributed to performance-based and brand advertising growth.

However, the upward momentum in Online Advertising growth was somewhat counterbalanced by a 28% decrease in content distribution revenue, which landed at $72.1 million. This dip was primarily driven by a reduction in the average unit price of barter transactions, offering insight into why iQIYI’s revenue growth remained within the single digits.

Cost Expenses Drive Improving Margin

In tandem with this robust revenue growth, iQIYI prudently controlled its total expenses, which grew by a mere 5% year-over-year in its most recent results.

The combination of economies of scale kicking in due to improving unit economics amongst subscribers and handling expenses prudently paved the way for net income margins to shift out of the red zone.

The LTM net margin has now reached 5.6%, while net income reached $65.2 million in Q3. It marked the fourth consecutive quarter of positive earnings.

Given the seemingly sustained trend of positive net income, iQIYI appears to be charting a promising course toward enduring profitability.

Why Is iQIYI’s Profitable Growth Likely Going To Last?

I am optimistic about iQIYI’s enduring positive net income trajectory, which stands out for its ability to effectively manage expenses while expanding its subscriber base—an achievement that distinguishes it from its Western counterparts.

In contrast to these rivals grappling with an oversaturated streaming industry, where numerous giants vie for market dominance, iQIYI navigates growth with remarkable resilience.

While Western streaming behemoths face challenges such as stagnant subscriber growth due to intense market competition, they also contend with substantial expenditures on content and advertising, impeding significant profit growth.

A notable case in point is Disney+, which has witnessed declining subscriber numbers in recent quarters, contributing to persistent operating losses in Disney’s DTC segment.

In sharp contrast, iQIYI operates in a market with limited direct competition from multiple streaming giants. Its market-leading position in China, without a close counterpart enjoying a similar scale, suggests iQIYI’s ongoing scaling of unit economics over time.

The Valuation – iQIYI Is Likely Cheap

Shares of iQIYI have appreciated in recent weeks, in line with most equities. Yet, I believe the stock remains cheap. Its forward P/E currently stands at just 12.2X, while based on Wall Street’s estimates, the stock is trading at 9.8X and 7.7X expected EPS for fiscal 2024 and fiscal 2025, respectively.

Being a Chinese company, I doubt investors will ever be willing to trade the stock at the premium multiples its Western counterparts may attract. Still, iQIYI’s forward multiples appear low enough to allow for the possibility of a notable P/E expansion.

With management ceasing diluting shareholders, rising net income, and iQIYI not facing as significant competition risks as its Western counterparts, I believe that investors’ confidence in the stock is likely to pick up.

Takeaway

In hindsight, my bearish outlook on iQIYI in 2020 and 2021 accurately reflected the company’s challenges, with its stock declining substantially. However, recent quarters have seen a remarkable turnaround, marked by consecutive positive free cash flows and a shift to profitability.

The resurgence in revenue growth, driven by an expanding membership base and encouraging trends in revenues per membership, has been a key factor. The company’s adept management of expenses has further contributed to improving net income margins.

Simultaneously, in a streaming landscape saturated with Western competitors, iQIYI’s distinct market position in China and its ability to navigate growth with resilience set it apart.

Finally, despite recent stock appreciation, iQIYI’s forward valuation metrics suggest it remains attractively priced. As the company continues its trajectory toward enduring profitability, investor confidence will likely grow – hence the shift from my earlier bearish stance to a more optimistic outlook.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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The post iQIYI: After 3.5 Years Of Hating The Stock, I Just Turned Bullish appeared first on Up2info.com.

• iQIYI, Inc.’s profitability is starting to show.
• The total addressable market is enormous, and the company has a lot of room for growth.
• High-quality programming is increasing subscriber count, while advertising is seeing a re-emergence, which will benefit the company.
• Even with the very conservative estimates, the company is a buy.

Investment Thesis

I wanted to take a look at iQIYI, Inc. (NASDAQ:IQ) to see if it would be a good time to start a position before it reports earnings close to the end of this month. The company is poised to come out of the hole and start to be profitable going forward and it seems like a turning point is upon us. The past financials were not looking the best; however, these have improved recently, therefore I initiated my coverage of the company with a buy rating and have opened a small position. There are risks associated with the company so please do your due diligence before committing your capital.

Comments on the outlook

Streaming

The company is known as the “Netflix of China”. It has been producing high-quality content for a while and has become the leading streaming platform in terms of long-form content like Netflix, Inc. (NFLX). It is hard to be a streaming business, and many similar companies are burning cash and not making any profits besides Netflix. IQ has been net income positive on a GAAP basis for the last two quarters now and the management is looking to maintain that momentum going forward citing Mr. Yu Gong:

“Our original content strategy continued to deliver top-notch titles, which in turn brought the strongest second-quarter performance in our history in terms of key metrics, such as total revenues, profits, free cash flow, and average daily subscribers.” Mr. Yu Gong also mentioned that the company is investing in many new technologies to better prepare IQ for future growth like Generative AI.

If the company can manage to produce high-quality content that got it to become profitable recently, I believe it will see its profits grow massively, and coupled with the revolution of AI, the company will be running more efficiently, thus more profitably going forward. Currently, the company has around 110m paying subscribers, which is a lot, however, the size of China and surrounding regions where IQ is available, is much bigger so the total addressable market is enormous. Netflix has around 247 million paying subscribers globally, and it is facing a lot of stiff competition. If IQ can grow its subscriber base consistently, the growth could be tremendous in my opinion.

Advertising Revenue

The advertising side of the business has seen massive growth over the last while, with the latest quarter showing a very healthy growth of around 25% y/y to $206m. There is a nice recovery afoot for the advertising side of the business as the performance ad revenue doubled in Q2 to reach a historical high, while still seeing acceleration in growth. The company is employing AI to enhance ad creation and improve ROI, and it seems to be working out for them as that is phenomenal growth.

The company saw an increase in ad revenues coming from their highly rated dramas, as more and more advertisers are signing annual contracts, so if the company can succeed in attracting a high subscriber base, the advertisers will continue to flock to the platform and average revenue per members or ARM will continue to improve over time.

Advertising works in streaming platforms, although as much as I hate seeing ads coming back and turning my on-demand platforms into cable once again, it’s been very profitable for many streaming platforms to offer ad-tier subscription services and IQ will not pass up this opportunity.

Analysts Estimates

So, with such high growth that the company achieved from the two main revenue generators, I was very surprised to see that analysts’ estimates for the revenues are rather lackluster. The company managed to achieve 17% revenue growth and the management appears quite optimistic for the future, especially in terms of advertising recovery. In my opinion, the company will see low-double-digit growth for the next couple of years if I’m being conservative, so I don’t agree with the analysts’ estimates. The company is the Netflix of China, with high-quality production content that can retain and attract high-quality subscribers. This, coupled with further advancements in AI that help tailor the content to be more efficient, is why I could see the company retaining its profitability going forward.

Briefly on Financials

As of Q2 ’23, the company had around $840m in cash and equivalents against around $1.6B in long-term debt. So how worrisome is this debt? Well, if we look at the company’s operating income and 6 months ended June interest expense, we get an interest coverage ratio of around 2.6. This means that EBIT can cover annual interest expense on debt 2.6 times over, which according to many analysts is healthy. I prefer to be more conservative and usually look for companies that can cover interest expenses at least 5 times over. This way I feel much safer when a company has a bad year or two and the coverage ratio dips below 5 but if it was at 2 already then, the debt is not manageable and there isn’t much wiggle room.

The company’s current ratio has not been particularly great over the last couple of years, and it has not improved in the latest quarter either. The company has a lot of short-term loans and deferred revenue, which makes sense given the business is subscription-based. So, I wouldn’t think this is very worrisome. The company is paying off the debt slowly so that should improve the ratio slightly over time. Netflix’s current ratio as of September ’23 stood just over 1.3 so it’s not too far apart but if Netflix can do it, so can IQ, therefore I will add a bit more margin of safety to my intrinsic value calculation.

In terms of profitability and efficiency, we can see that these have improved dramatically over the last while and are in the positive territory, which looks like a turnaround to me that is going to hold up because of the management’s focus on high-quality content and subscriber retention. These are the reasons the company finally became profitable in my opinion. The metrics aren’t very impressive yet, however, it does seem like it is the beginning of an uptrend and only time will tell if the company succeeded.

In terms of GAAP margins, historically these have been horrible, to say the least, however, we can clearly see massive improvements over the years, and as of Q2 ’23, gross, operating, and net margins were 27%, 9%, and 6%, respectively, which is quite an impressive improvement.

Overall, there is a clear turnaround in the company’s profitability and I would like to see this continuing over the next couple of years, however, it is still too early to tell if it will be sustainable. I believe that the period of unprofitability has passed and now the company will be profitable going forward.

Valuation

I said that I don’t believe the company’s revenues are going to grow as slowly as the analysts are saying, however, to be on the conservative side of things I decided to go with similar growth rates. This way I will get an extra margin of cushion. Below are my assumptions for the three cases.

In terms of margins and EPS, I decided to lowball estimates compared to the analysts as well for even more cushion. Below are my estimates.

For the DCF analysis, I went with the company’s weighted average cost of capital or the WACC of around 7% as my discount rate and 2.5% for the terminal growth rate. On top of these estimates, I went ahead and added another 30% margin of safety to give me that sleep-well-at-night feeling that I need with all my investments. With that said, IQ’s intrinsic value is $6.86 a share, implying that the company is trading at a 40.5% discount to its fair value.

Risks

The opening up of China may present a slight slowdown in subscriber count since fewer people are going to stay at home all day and watch internet shows. So far, the re-opening has been rather slow, which is good for the company, however, there will be a time when people decide to hang out with their friends and family in the restaurants rather than facing a screen.

Since it is a Chinese company, there are going to be those whole political risks, where the Chinese government is very unpredictable, and the tensions between China and the US are still the talk of the town. Many investors tend to avoid Chinese names because of it and the company may never reach its full potential.

There is also around 11% short interest on the company, which not only supports my thesis on the dislike of Chinese names but also there could be something that I don’t know that will bring down the stock further. On the other hand, we could see another rally as short sellers start to cover their positions, but that fad seems to have subsided about a year ago when many companies saw their share price increase due to GME/AMC fiasco.

Closing Comments

It seems that it is not a bad time to start a position here as it looks like the company is seeing a turnaround and is becoming profitable. I have opened up a small position recently and will see how it develops over the next couple of years, but I believe that the risk/reward is very attractive here, and if the share price comes down after the earnings while the long thesis is still intact, I will most likely develop the position fully and give it a few years before selling it.

The risks are something to think about, however, I believe that the worst has been priced in already and I am putting my trust in the management of the company to reward the company’s shareholders in the long run.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of IQ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post iQIYI: Risk/Reward Very Enticing Even With Beaten-Down Estimates appeared first on Up2info.com.

• iQIYI continues to showcase sustainable profitable growth with increased revenue and membership services growth.
• Operating income has more than doubled, indicating high incremental margins inherent in the business model.
• The company’s focus on optimizing subscription revenue and upcoming high-quality content releases are expected to drive subscriber numbers.

Summary

Following my coverage of iQIYI (NASDAQ:IQ), I recommended a buy rating due to my expectation that IQ will continue to report sustainable, profitable growth. This post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for IQ as the business continues to showcase sustainable profitable growth, especially with content cost moderating as a percentage of revenue while consistently putting out blockbuster hits. The improved outlook for advertising also reinforces my positive outlook that margins should continue to increase.

Investment thesis

The 17% increase to RMB 7.8 billion in revenue met market forecasts. Membership services brought in RMB 4.9 billion in revenue, up 15% year-over-year. It’s important to keep in mind that the drop from 128.9 million in 1Q23 to 111.2 million in the daily average number of subscribers is likely due to subscribers hopping on and off as they finish a particular drama or movie. Earnings from online advertising also increased, reaching RMB 1.5 billion, a 25% increase from the previous year. A key statistic to highlight is the operating income growth, which skyrocketed to RMB 786.4 million, more than doubling the 2Q22 figure of RMB 344 million.

As IQ continues to shift its focus from optimizing subscriber growth to growing subscription revenue, I remain optimistic about the future of subscription revenue. Going forward, I anticipate stable ARM improvements as IQ releases more high-quality content and decreases the frequency of discounts. Regarding the former, I believe it is well supported by a strong pipeline schedule. The Story of Kunning Palace, The Demon Hunter’s Romance, My Journey to You, and A Journey to Love are, according to my research, the next “hit” films and dramas to be released. Of course, everyone has their own tastes, so it all comes down to personal opinion. But my expectation is that Chinese drama will continue to gain attention in the coming years, which is a trend that K-drama is undergoing currently. Given that the upcoming content has a similar style to recent historical Chinese drama success, I think their release will be the main factor in growing the number of subscribers in 2H23. My expectation is that IQ’s subscription revenue visibility will improve further in the long run as the proportion of annual subscribers increases. This would be contingent on IQ continuing to release blockbuster hits, which I think they can.

Let me emphasize again how important it is to prioritize long-term, profitable growth. So, it was heartening to learn that despite increases in both quantity and quality, the price of content did not rocket. Consistent with my prediction that IQ’s margins will grow steadily as a result of its growing quality subset and decreasing production costs, IQ has remained committed to registering healthy content cost. To put this in perspective, in 2Q23, content cost rose by only 7% to RMB4.1 billion, resulting in a drop from 58.6% of revenue in 2Q22 to 53.1% in 2Q23 of revenue as a result of positive leverage.

Margins should also further improvement as the high margin business – Advertising – come back online. Brand advertisements, in particular, have been on the upswing, according to management, thanks to IQ’s release of successful content hits (this also lend credence to my point that IQ released content are hitting the right spot in terms of consumer preference). Moreover, growth in performance advertising is outpacing that of brand advertising, and management anticipates a healthy recovery in 2H23 as a result of rising demand in the online retail, media, and travel sectors. I anticipate more subscribers joining the platform as IQ continues to release blockbuster hits, which will increase the value that IQ can provide to advertisers and, in turn, increase advertising revenue.

Conclusion

I reaffirm my buy recommendation, as IQ demonstrates a clear trajectory of sustainable, profitable growth. The recent financial results, including increased revenue, membership services growth, and improved operating income, underscore the effectiveness of IQ’s strategic shifts. As the company focuses on optimizing subscription revenue, bolstered by an array of upcoming high-quality content releases, I anticipate a substantial uptick in subscriber numbers. The controlled content cost, steady margins, and resurgence of high-margin advertising further solidify the positive outlook.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

The post iQIYI: Path To Sustainable Profitable Growth Continues appeared first on Up2info.com.