Since its initial public offering (IPO) earlier this year, iQiyi (IQ 0.85%) -- which has been called the "Netflix (NFLX +2.60%) of China" -- has been something of a roller-coaster ride for investors. The stock soared as much as 184% before giving back some of its gains, and it's currently up nearly 70% since its debut in late March. While investors should expect that volatility to continue, at least one analyst has joined the ranks of iQiyi bulls and thinks there are much greater gains to be had over the coming year.
Analyst Karen Chan of Jefferies & Company started coverage of iQiyi, giving it a buy rating with a price target of $33 -- 25% above the current stock price. In a note to clients, Chan wrote, "Although iQiyi's paying subscriber base of 67 million already surpasses that of Netflix domestically, conversion is still at early innings."
Chan went on to point out that Netflix had a 42% penetration rate in 2017, while iQiyi's paying subscribers accounted for just 10% of Chinese households. Chan laid out three main reasons she thinks iQiyi could match Netflix's success, sending the stock soaring from here.
iQiyi's Story of Yanxi Palace has had a record-breaking run in China. Image source: iQiyi.
1. First-rate content
Chan believes iQiyi is developing a reputation for quality content, as evidenced by the company's hit program Story of Yanxi Palace. iQiyi revealed last month that the 70-episode period piece had been viewed over 15 billion times, and it was the most-watched online drama in China for 39 consecutive days. The show was streamed on average 300 million times per day, at its peak producing a record-breaking 700 million views -- half of China's population -- in a single day. This is just one of a number of iQiyi's original shows that have gone viral in China.
Chan wrote, "As original content becomes more quality- than quantity-driven, iQiyi should benefit with a proven track record." Chan believes this should help accelerate the migration from linear TV to digital platforms, with iQiyi as the biggest beneficiary, due to its position as China's streaming leader. "Original content guarantees exclusivity, converts and retains paying subscribers, while expanding innovative advertising and intellectual property-related monetization potential," Chan concluded.
2. Improving monetization
iQiyi currently has 565 million mobile monthly active users (MAUs), of which 67 million are currently paying subscribers, and the company boasts the highest share of time spent by viewers among its streaming peers, Chan wrote, citing data from Questmobile. iQiyi has a free, ad-supported tier that encourages viewers to sign up for exclusive and commercial-free content.
Chan expects iQiyi's paying subscribers to jump to 84 million, which would represent 20% of China's streaming viewers by 2020, and she believes iQiyi will ultimately control 40% of China's mobile MAUs. "We estimate fiscal year 2017-2020 revenue compound annual growth rate of 39%, driven by 48% [growth] in subscriptions and 30% [growth] in advertising," Chan wrote. The analyst also thinks online platforms are "under monetized" compared to the traditional on-air competitors, and she sees iQiyi closing the gap.
iQiyi original program "Hot Blood Dance Crew" smashed industry records for advertising. Image source: iQiyi.
3. Declining costs
As iQiyi's subscriber base increases, the cost per user will continue to decline, according to Chan. Content costs as a percentage of sales will likely peak in 2018 at about 87% of sales, and they will eventually decline to a range of 50% to 60% of sales.
Additionally, the increasing percentage of original content will be more cost-effective than iQiyi's current roster, which boasts a large amount of licensed programming. The "rising mix" of self-produced original shows will ultimately drop more profits to the bottom line.
It won't be a straight line
If the company's short history is any indicator, iQiyi's stock will continue to be volatile, but Chan believes there is still much "low-hanging fruit in conversion of paying subscribers," given its market-leading position and its track record at generating quality original programs. In its most recent quarter, iQiyi increased revenue by 51% year over year, while its paying subscriber base jumped 75% compared to the prior-year quarter.
Given its record thus far, there isn't any indication that iQiyi's success won't continue.
