Baidu, Inc. (BIDU -0.66%) is primarily known as the leader in online search in China, but the company has also made big bets in the areas of artificial intelligence (AI) and self-driving cars. Another massive investment it makes that grabs far fewer headlines is in streaming video on demand (SVOD) through its iQiyi service, similar to what Netflix, Inc. (NFLX 0.19%) offers U.S. consumers.
Streaming video is hugely popular in China, with an estimated 144 million subscribers tuning in this year, up 80% over last year. That number is projected to grow to 234 million by 2020. Analysts at JPMorgan (via eMarketer) forecast that iQiyi will continue its market leadership with 99 million subscribers this year, up 120% over 2016.
Baidu is seeking to capitalize on consumer's insatiable appetite for new content by spinning off iQiyi, with an initial public offering (IPO) that would value the company between $8 billion and $10 billion, and debut on U.S. markets as early as 2018, according to a report from Bloomberg. Baidu still plans to hold a controlling interest after the IPO by issuing dual-class shares.
A growing opportunity
Once upon a time, online content in China was free and supported by advertising. Content providers began to charge for the most popular new releases, and thus began the transition to paid subscriptions. iQiyi added a paywall and premium content in mid-2015, and subscribers quadrupled over the next year. Since the change, Chinese consumers have rushed to embrace the paid subscriber model.
According to market intelligence company IHS Markit, China's online video market will quadruple from $3.5 billion in 2015 to $17.6 billion in 2020. With this mounting opportunity, competition is heating up as well. iQiyi's streaming service competes with Youku Tudou, controlled by e-commerce giant Alibaba (BABA -1.11%), and Tencent's (TCEHY -0.73%) Tencent Video for China's digital video customers. Tencent will attract an estimated 81 million subscribers this year, while Youku Tudou will draw 43 million.
Baidu has been devoting an increasing amount of its revenue to acquire content for the unit, spending $459 million last quarter, and $1.54 billion -- over 14% of its revenue -- over the last year on programming.
Billions for content
An IPO for iQiyi would accomplish several strategic objectives for Baidu. The fresh infusion of cash would provide the company with a war chest for content, which would help the company maintain its subscriber lead against Youku Tudou and Tencent Video.
Baidu has increasingly focused on artificial intelligence (AI), which is consuming an increasing amount of the company's resources. In its most recent conference call, CEO Robin Li revealed that Baidu had revised its mission statement of focus on two strategic pillars: strengthening its mobile foundation, and to lead in the area of AI.
iQiyi also isn't profitable. In its second-quarter 2017 earnings release, Baidu reported that losses at iQiyi reduced non-GAAP operating margins by 11.5% for the quarter. Spinning off iQiyi would improve Baidu's financial position and results, while still maintaining control of what could be a potentially lucrative asset in the future.
Netflix in China
Baidu likely hopes that the funds provided by the IPO will help iQiyi evolve into the Netflix of China. It is notable that iQiyi licenses Netflix original content in the most populous country, as Netflix found it difficult to navigate the regulatory environment there.
A successful spinoff of its streaming unit will be a win for Baidu and its investors, though for now, the company has yet to confirm these plans.