On this episode of Industry Focus: Tech, Dylan Lewis is joined by Fool.com contributor Danny Vena to discuss iQiyi (NASDAQ:IQ). The Chinese streaming powerhouse soared 20% after reporting better-than-expected growth -- and it's probably just getting started.

A full transcript follows the video.

Check out the latest earnings call transcript for iQiyi.

This video was recorded on March 1, 2019.

Dylan Lewis: All right, Danny, let's switch gears here and talk about another company. This is one we own. It's one we talked about before on the show. I actually had you on to do the breakdown of their prospectus right around the time that they were going public. iQiyi, what we would colloquially refer to as the Netflix of China.

Danny Vena: That's exactly right. It is typically called the Netflix of China. I tried to change people's view of that as much as I can by saying it's more than that. While Netflix is primarily a subscription-based business, and that's all they do, iQiyi operates in a little different culture in China. Historically, people in China were not used to paying for video. That's something that iQiyi started doing when they were still owned by Chinese search giant Baidu a number of years ago. They put up a paywall, they put in some premium content, and they began encouraging subscribers to move over to the subscription service. Now, they still have both, they still have an ad-supported service similar to Hulu, and they have a subscription-based service similar to Netflix. They actually do have the best of both worlds there.

Lewis: Thinking about where the business is going, membership services revenue up 76% in the most recent quarter. Advertising revenue, 9%. It's clear where the business is going. They're a little bit more reliant on the membership services side than the advertising for long-term growth. Something that is interesting with them, too, makes them a little different than Netflix, is that they also have some other revenue segments out there.

Vena: They do. In addition to the subscription revenue that they get from members, and we've already mentioned the ad revenue, they also have two other segments that they use. One of them is content distribution. Imagine if Netflix, with some of its original content, said, "There are so many people that are never going to see this. Why don't we license this out for a period of time for them to show it on TV, for it to be used by other streaming services?" So, they get revenue from licensing out their content.

The last segment that they have is other. Their other segment includes merchandising and video games that are based on the company's original content. Similar to what Netflix is doing with, say, their hit series Stranger Things. You can go into stores and you can buy your favorite Stranger Things character on a coffee mug or on a T-shirt. iQiyi is doing that with its hit programs. You can go buy T-shirts and coffee mugs. Or, you can download a video game and play it on your phone that's based on characters from their TV programs.

Lewis: Both of those segments are smaller portions of the overall revenue pie for iQiyi, but both up over 100% year over year in the most recent results. You put it all together, this is a company that grew 55% year over year. Pretty incredible. Both beating guidance and analyst expectations on Wall Street. A big part of that is the fact that the member base for this company keeps going up.

Vena: They're following the Netflix playbook. For years, the bears have said, "There's no way that Netflix is going to be able to do this," and yet they continue to do it. What they have done, several years ago, going back to about 2013, Netflix said, "Instead of licensing content from other people, we're going to produce our own content." Then it went from producing some of their content now to they actually produce and own some of their content. That's a model that iQiyi has embraced. They're quickly building out their own library of content.

Some of these programs are massive, massive hits in China. One that I refer to from last year is called Hot Blood Dance Crew, which is a reality program that pits street dancers against each other in a competition. It became one of the most-watched programs in China. It had billions of views over the 24 or 26-week production. Billions of views. Became one of the most-advertised programs in the country.

Again, they're following the Netflix playbook on original content. They spent nearly $1 billion on content. If you look back, they actually had only $1 billion in revenue, so they're essentially spending every dollar that they have on content and going into the hole a little bit on some of their other expenses. But they have Baidu as a parent, and they have huge backing. They've got a couple of billion dollars in the bank after having recently acquired some debt. They're really in a good place right now just to continue building out that library of content and following the Netflix playbook. And with 1.3 billion people in China they've really just scratched the surface of their potential subscriber base.

Lewis: One thing that does separate the Netflix model from iQiyi is, Netflix, to a lot of fanfare, really dramatically expanded a couple of years ago and said, "We're targeting well over 100 countries," and they did it pretty quickly. The content travels very well. What'll be interesting to see with iQiyi is, we have something like 90 million members, give or take. The total market, about 1.3 billion in China. Are they able to get outside of China with that member base? Because then the growth becomes even bigger as a runway. I'm not as sold on that, but I look within the country and I say there are still a lot of prospective members out there for them to add.

Vena: Absolutely. If you look at their membership base right now, I think their reported subscriber numbers grew to just over 87 million. To put that into perspective, I think Netflix's subscriber numbers just in the United States in the last quarter was somewhere in the neighborhood of 56 million. They've already exceeded the number of subscribers in their home country that Netflix has in the United States. Again, there's 1.3 billion people in China. If you put that in perspective, in the United States, I want to say there's 325 million --

Lewis: Yeah, 340 million, something like that.

Vena: They have 4X the potential customer base in China than Netflix has in the U.S. They still have a lot further to go.

Lewis: You mentioned Baidu. Obviously, it's super helpful to have a former parent company that has pretty deep pockets and knows a thing or two about tech and consumers. This company has also been pretty brilliant in the strategic partnerships they've gone out and inked to help them reach more members and make it easier to sign up for their services.

Vena: That's true. If you are a consumer in China, you have heard of JD.com, which is one of the larger e-commerce platforms in China. You've heard of China Mobile, which is one of the most ubiquitous cellphone services, similar to AT&T or T-Mobile in the United States. You've probably heard of Ctrip, which is the Chinese version of booking.com, formerly Priceline. These are well-known names to Chinese consumers.

What iQiyi has done is, they've gone out into the market and they've partnered up with these customers. For instance, with JD.com, they did a special deal where you can get a membership to both, the premium membership to JD.com and subscriber benefits from iQiyi, all for one price. You pay the price for just one and you get both services for the course of a year. What they're banking on -- and I think they're right to do so -- is that once people get on the service, they get used to watching their favorite programs, they become enthralled with the content, they're going to continue that relationship. Same thing with China Mobile. Same thing with JD.com, Ctrip. All of these companies, once they sign up for these benefits, these companies are hoping that they will stick around. I would argue that iQiyi is in the best position to benefit from these relationships.

Lewis: Yeah. You look at them, it's kind of Netflix a couple of years ago, in terms of where they are in their growth plan. You see that in their content spend now. It's a fraction of what Netflix's content spend currently is. Their revenue is also a fraction of what Netflix's current revenue is. But the playbook has been so well executed by Netflix, and iQiyi almost has a look into the future because Netflix is several years ahead of them, in this sense. The model is so strong, the customer satisfaction seems so strong, and they similarly have these cultural-event-type shows that they're able to release and really just take over whatever the social conversation is. I think they've done a great job executing. Happy to be a shareholder!

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