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iQiyi's Loss Widens, But Its Game Plan Hasn't Changed

By Danny Vena – Nov 1, 2018 at 7:35AM

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The company continues to spend heavily to steal market share.

Since iQiyi (IQ -3.90%) made its market debut in late March, investors have been treated to the thrills and spills usually reserved for the best roller coaster rides. It fell briefly on its first day of trading, only to soar as much as 193% in the months that followed before losing half its value during the recent market rout. Fears related to a slowing economy in China and escalating trade tensions have taken down a broad swath of Chinese stocks, and iQiyi was no different.

Frequent comparisons with Netflix aren't an apples-to-apples proposition, as the company's business model is much closer to that of Hulu, but one thing they definitely have in common is iQiyi's willingness to spend heavily on its growing library of content. When the company reported the financial results of its third quarter, investors were hoping that the news was good enough to allay broader market concerns, but its voracious spending gave iQiyi investors a fright.

Women in traditional Chinese attire, in a scene from the iQiyi original program "Story of Yanxi Palace."

iQiyi original program Story of Yanxi Palace was a smash hit. Image source: iQiyi.

Solid top-line growth in most segments

iQiyi reported revenue of $1.0 billion, an increase of 48% year over year in local currency and after adjusting for a recent change in accounting standards. This topped analysts' consensus estimates of $996 million and came in at the high end of management's forecast. The company reported a net loss of $457.3 million, nearly tripling its loss from the prior-year quarter, resulting in a loss per share of $0.63, much higher than the $0.44 loss per share predicted by analysts.

iQiyi reported solid growth in the majority of its segments:

Metric

Q3 2018

Q3 2017

Change (YOY)

Membership revenue

$415.3 million

$247.4 million

78%

Online advertising service

$348.9 million

$383.5 million

(4%)

Content distribution

$121.5 million

$40.2 million

220%

Other

$121.0 million

$50.0 million

157%

Data Source: iQiyi Third-Quarter Financial Results. Differences due to changes in exchange rates.

Membership services revenue climbed 78% year over year, driven by robust growth in paying subscribers. The company's subscriber base grew to 80.7 million, up 89% compared to the prior-year quarter. More than 98% of the company's subscribers are now paying members. iQiyi increasingly relies on its subscriptions to offset its growing content spending.

Online advertising services revenue fell 4% year over year due to the impact of the FIFA World Cup Soccer championships and recent regulatory headwinds in China that crimped advertiser spending.

Content distribution revenue grew a whopping 220% year over year, as iQiyi was able to better monetize its growing library of premium content.

Other revenue climbed an impressive 157%, driven by iQiyi's acquisition of mobile gaming developer Skymoons in mid-July, as well as strong growth in the company's ancillary businesses such as online games and content merchandising tied to its original programs.

The cost of revenue soared to $1.1 billion, a 66% increase year over year. The primary factor was iQiyi's continued significant investment in self-produced content to build out its "comprehensive and diversified content library." The company also saw higher amortization of licensed copyrights.

Both selling, general, and administrative expenses (SG&A) and research and development (R&D) expenses increased, to $188 million and $81 million, respectively, up 66% and 63% year over year. Greater marketing spending and headcount in the R&D department drove the higher spending.

Other news

iQiyi recently announced that it would debut more than 200 new programs next year, running the gamut from variety shows to animation and from movies to reality shows. The company will also renew some of its fan favorites, including The Rap of China and Idol Producer

The company also announced that it will be adjusting its original content strategy to better align with the desires of its viewers by placing more emphasis on the production of short dramas of 12 episodes or fewer. iQiyi is also testing programming specifically formatted for smartphone users.

Proud parent Baidu (BIDU 0.80%), which still owns a controlling stake in the streaming service, boasted in its earnings report that iQiyi original Story of Yanxi Palace garnered more than 20 billion video views during the recent run of the series. Baidu also said that iQiyi ranked No. 1 across reach and engagement metrics during the third quarter 2018, according to third-party market research firms. 

Three young children sitting on a couch looking at a tablet.

Image source: Getty Images.

Looking ahead

For the upcoming fourth quarter, iQiyi management expects revenue in a range of 6.48 billion yuan to 6.75 billion yuan, or between $943.5 million and $982.8 million at current exchange rates. This would represent revenue growth of between 43% and 49% year over year. For their part, Wall Street analysts' consensus estimates are calling for revenue of $974.31 million and a loss per share of $0.35.

It's important to keep in mind that iQiyi is a young company in its early stages of growth, and as such, it is spending lavishly to gain market share. What makes this different than many start-ups, however, is a strong corporate parent in Baidu. The search giant provides a solid backstop, which will allow iQiyi to make the necessary investments to continue to compete in an increasingly crowded field.

The company's widening loss notwithstanding, the story hasn't changed for iQiyi, and it continues to rapidly expand its original content library and follow the example set for it by Netflix, which has successfully parlayed this strategy into becoming the world's leading streaming provider. I don't expect things to be any different for iQiyi in China.

Danny Vena owns shares of Baidu, iQiyi, and Netflix. The Motley Fool owns shares of and recommends Baidu and Netflix. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.

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