Please ensure Javascript is enabled for purposes of website accessibility

Is iQiyi a Buy?

By Keith Noonan – Jun 14, 2019 at 9:18PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The Chinese streaming-video company has been rocked by trade troubles and a slowdown for its ad business. What's next?

Market volatility has been difficult to avoid over the last year, and iQiyi (IQ -7.08%) stock has seen more pricing whiplash than most. The streaming video company's stock hit the market last March 2018 at $18 per share after the unit was spun off from Baidu (BIDU -0.38%). Its share price climbed as high $46 last June, thanks to strong revenue growth and excitement that it could solidify itself as "the Netflix of China," but the stock has been pushed far below that high mark on the heels of mounting losses, and worsening trade relations between China and the U.S. that threaten to stall the latter country's economic growth.

I've been buying iQiyi stock periodically since shortly after its initial public offering, and even named it as my top pick for the month of May -- when the stock was trading in the $22 range. How have shares performed since then? Not very well. The stock is back to trading in the range of its IPO price, down roughly 16% since my May recommendation, amid pressures created by escalating trade tensions between the U.S. and China, a mixed first-quarter report, and worrying guidance. The past month has been rough for iQiyi shareholders, and the near-term outlook for its second-largest business segment has shifted. Is the stock still a buy for risk-tolerant investors, or does the streaming-video company look like plenty of promise wrapped around a weak core?

A bull facing a bear underneath a stock-chart line

Image source: Getty Images.

Great subscription performance vs. a dismal advertising outlook

iQiyi shareholders and those watching the stock have gotten used to sizable net losses each quarter, as the company builds up its content library, invests in its technology and distribution infrastructure, and moves to ramp up its business in video games and social media. It added 9.4 million new subscribers in the March quarter, bringing its total member count to 96.8 million -- a 58% year-over-year increase. Overall sales in the period grew 43% compared to the prior-year period, and the net loss for the period actually came in substantially lower on a sequential basis, at roughly $270 million. Taken on their own, those results could have very well sent its stock price substantially higher, but guidance for the current quarter was undeniably disappointing.

Investors expect strong sales momentum from iQiyi, and must now evaluate how they feel about a substantial deceleration to targeted sales growth between 12% and 18% in the current quarter, due to big headwinds for the company's advertising segment. There's a place in my portfolio for ambitious growth stocks -- even ones that, like iQiyi, have market caps in the $13 billion range and have posted quarters with net losses arriving in the $500 million range. That dynamic becomes a lot less palatable when revenue growth is only arriving in the mid-teens. Start stringing quarters like that together, and a company (regardless of some standout individual strengths, and big growth potential in its industry and geographic markets) immediately becomes unappealing to most investors.

Sales for the ad segment in the first quarter were roughly flat compared to the prior-year period, and down slightly on a sequential basis, but the ad business is on track for a substantial decline in the current quarter. Based on comments from management that its outlook for the ad business has shifted to "cautious" (a shift from the "cautiously optimistic" outlook it delivered with its Q4 report), there's a good chance that ad revenue will fall significantly compared to 2018. That means that growth for its membership services, content distribution, and "others" segments will be needed to offset the decline, and shareholders are looking at a substantial deceleration for overall sales growth this year.

I don't think iQiyi's long-term growth trajectory has shifted dramatically, and I still think it's a worthwhile buy for investors who see long-term potential in the Chinese market and streaming-video distribution. However, investors without a buy-to-hold approach and a stomach for volatility may want to stay on the sidelines until China's economic outlook becomes more clear, and there's a better look at what's happening with the advertising business.

With time, subscriber growth should overcome weakness for ads

China's population of roughly 1.4 billion (and its internet-using population of more than 700 million) is a huge market with growing purchasing power; expansion for the country's middle class, and increased per capita discretionary spending, are important parts of most bullish takes on iQiyi. Unlike hardware-centric businesses (such as semiconductors, industrial equipment, or automobiles), it isn't directly vulnerable to tariffs and other trade-related dynamics, but the overall health of the Chinese economy can reasonably be expected to impact iQiyi's business.

While the ad business appears to have been disrupted because small and medium-sized businesses in China are less willing to spend on advertising with economic growth slowing, the outlook in other segments remains promising. The company also maintained its guidance that subscriber additions for the full year would be roughly in line with 2018, putting it on track to add roughly 36 million subscribers in the year, and to close out 2019 with somewhere in the neighborhood of 120 million premium subscribers.

The proportional contribution of the advertising business was already trending downward amid big growth for iQiyi's three other segments, and I expect that time will recast ad-segment turbulence as a bump in the road. There's little doubt that streaming video will continue to gain ground, and that China's entertainment industry is likely to see strong growth so long as the country's economy remains reasonably healthy.

A risky buy, but big return potential remains

iQiyi's faltering advertising business presents a meaningful setback in the short term, and investors were right to react negatively to the company's growth target for the current quarter. On the upside, the member services business looks substantially stronger than it did a year ago; encouraging growth for the segment appears to be on track to continue; and iQiyi's membership revenue continues to grow faster than content costs -- paving the way for a shift to profitability and potentially explosive growth, if the company can continue to grow the user base and implement gradual price hikes.

iQiyi is now valued at just three times this year's expected sales; that's a valuation that would have looked downright delectable when shares hit the market. But with the ad segment dragging down growth and a range of broader macroeconomic concerns looking more pressing, the picture is more complicated. Investors without high risk tolerance should probably look elsewhere, and being bullish on China's long-term economic outlook may be prerequisite to staking a position in iQiyi. But at current prices, the stock presents an appealing risk-to-reward dynamic.

Keith Noonan owns shares of Baidu and iQiyi. The Motley Fool owns shares of and recommends Baidu and Netflix. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.