Baidu's (NASDAQ:BIDU) streaming video unit iQiyi (NASDAQ:IQ) made its public debut at $18 per share on March 29. The company raised $2.25 billion during its IPO, making it the second biggest Chinese listing in the U.S. after Alibaba's (NYSE:BABA) public debut in 2014.
However, iQiyi tumbled nearly 14% to $15.55 by the end of the first day. That nasty start, which makes iQiyi a "broken IPO," was likely caused by concerns about the company's profitability and the threat of a trade war between the U.S. and China.
Should contrarian investors consider iQiyi's post-IPO plunge a buying opportunity? Let's dive deeper into its business to find out.
Understanding iQiyi's business
iQiyi is often called the "Netflix (NASDAQ:NFLX) of China," but it isn't a fully subscription-based platform like Netflix. Instead, it runs on a freemium model which consists of free ad-supported content and paid a la carte and subscription content.
The company finished last year with 424.1 million PC monthly active users (MAUs). Its mobile MAUs grew 4% annually to 421.3 million mobile MAUs, while its paid subscribers surged 68% to 50.8 million. Its daily average user hours spent on the platform also rose 16% to 300.1 million. Its mobile users spent an average of 1.7 hours on the platform per day.
How fast is iQiyi growing?
iQiyi's online advertising revenues grew 44% to 8.16 billion yuan ($1.25 billion) last year, but that marks a slowdown from 66% growth in 2016. Its membership revenues rose 74% to 6.54 billion yuan ($1 billion) last year, which also represents a slowdown from 278% growth in 2016.
iQiyi's membership revenues rose from 33.5% of its total revenues in 2016 to 37.6% last year. The company expects that percentage to "remain at a similar level" this year. That slowdown is worrisome, since iQiyi needs to generate more revenues per user from membership fees than ads to offset higher content licensing costs.
iQiyi currently holds content licensing deals with companies like Lions Gate, Paramount, and Netflix. It also previously bought the rights to a library of South Korean films, and partnered with Japan's Fuji TV to produce new online shows. iQiyi plans to use about half of its IPO proceeds to produce new content.
iQiyi's total revenues grew 55% to 17.38 billion yuan ($2.67 billion) last year, compared to 111% growth in 2016. Meanwhile, its net loss widened from 3.07 billion yuan to 3.74 billion yuan ($574.4 million) last year. That combination of slowing revenue growth and widening losses makes iQiyi's business look a bit shaky.
We should also note that iQiyi was a dead weight on Baidu's bottom line prior to its IPO. Therefore, Baidu's spinoff of iQiyi -- which it will retain a near-70% stake in -- will boost its profitability. But as for iQiyi, it's unclear if the stand-alone company will ever achieve profitability.
Understanding the competition
Baidu CEO Robin Li claims that iQiyi is China's largest video streaming platform, declaring that it had "surpassed everyone" in the market. However, iQiyi is roughly tied with Tencent (OTC:TCEHY) Video for the top spot.
Tencent Video hit 457 million MAUs last August, according to QuestMobile and Jefferies. Last November, Tencent disclosed that the platform had 43 million paid subscribers. Like iQiyi, Tencent Video uses a freemium model and holds content licensing partnerships with HBO, the NBA, and half a dozen British media companies.
Alibaba's Youku Tudou ranks third in the video streaming market. It had about 325 million MAUs as of last August, according to QuestMobile and Jefferies. At the end of 2016, Youku Tudou claimed to have 30 million paid subscribers.
Baidu, Tencent, and Alibaba all leverage their ecosystem strengths to promote their streaming video platforms. Baidu owns China's top search engine; Tencent owns WeChat, the country's top mobile messaging app; and Alibaba is the 800-pound gorilla of the e-commerce market.
So is iQiyi a broken stock?
iQiyi now has a market cap of about $11 billion, which means that it trades at about 4 times trailing sales. That's much lower than Netflix's P/S ratio of 11. However, Netflix reaches more countries than iQiyi, its revenue growth remains stable at about 30%-40%, it only generates revenues from subscriptions, and it's profitable.
I think that the iQiyi IPO is great news for Baidu, since it takes losses off its bottom line. I own shares of Baidu, but I wouldn't buy shares of iQiyi yet. Its growth is slowing down, it has no clear path toward profitability, and it still faces lots of tough competition.