The trade tensions between China and the U.S. have taken their toll on Chinese tech stocks recently, but that has only made iQiyi (IQ 0.33%) and Alibaba (BABA -0.91%) more appealing as valuations have come down. Both companies posted robust growth rates last year, and while there could be some speed bumps in the near term, the long-term prospects for iQiyi and Alibaba look bright.
Let's review both companies' recent performances and competitive positions to see which stock is the better buy.
iQiyi has one of the largest video-streaming services in the Middle Kingdom. The company currently has 96.8 million subscribers out of more than 600 million who watch online video in China. Meanwhile, Alibaba serves 721 million mobile users with its retail marketplaces, including Taobao and Tmall.
Recent performance shows iQiyi growing faster than Alibaba. iQiyi has seen strong membership growth for its video-streaming service as Chinese consumers are becoming more willing to pay for a subscription instead of watching ad-supported content. Last year, iQiyi's top line soared 55%, driven by an increase in paying members of 72%.
However, iQiyi's revenue growth decelerated to 43% in the first quarter. The company's online advertising business took a hit as businesses in China are holding back on ad spending given the economic uncertainty in the short term. Management anticipates a further deceleration next quarter, with total revenue expected to increase between 12% and 18% in the second quarter. Investors expect much more growth, which is why the stock is down about 33% over the last three months.
Alibaba didn't grow as fast as iQiyi last year, but the retail giant's adjusted revenue growth rate of 39% is nothing to sneeze at. It's more impressive when you realize that Alibaba is a huge business with a market value of about $411 billion. The commerce business generated $853 billion in gross merchandise volume over the last year, led by the dominance of its Tmall retail marketplace. American brands rely on Tmall to market their goods to Chinese consumers who want authentic merchandise and not a counterfeit, which is a big problem in China.
Alibaba doesn't see China's economic issues affecting its business. Management expects revenue to increase by approximately 33% this year, which is not much of a deceleration from last year's 39% growth rate, excluding acquisitions.
China's middle class is estimated to double in size to about 600 million over the next decade. Alibaba sees that increase transforming China to a consumption economy as opposed to a net exporter of goods. This transformation is enormously beneficial to Alibaba's retail businesses.
Alibaba relies on foreign brands to sell their goods through its marketplaces to drive growth, so a favorable outcome to the trade war would likely benefit Alibaba with a long tailwind of growth for many years. The main benefit for iQiyi would be the removal of uncertainty over the economy, which would boost its advertising business in the short term.
Because of its Chinese-oriented content, iQiyi is not able to expand its streaming offerings internationally the way Netflix can. To drive growth over the long term, iQiyi is making progress to diversify its revenue across several areas. In the last quarter, revenue from "other" businesses, including online games, consumer products, and social media, increased 143% year over year and comprised 14% of total revenue.
Despite the near-term obstacles with the ad business, iQiyi is well positioned for growth, but it's tough to overlook how dominant Alibaba is across different industries. Not only is Alibaba the largest e-commerce platform in China with a 53% market share, but it's also the largest cloud provider and shares a duopoly with Tencent in the mobile payments market.
iQiyi may eventually bounce back and surpass Alibaba's annual revenue growth rate once trade tensions are resolved, but Alibaba is proving to be more resilient to economic issues. Because of the poor performance from iQiyi's ad business right now, Alibaba will likely grow its top line faster than iQiyi this year.
Which is the better buy?
This is an ideal time to go shopping for Chinese growth stocks. Valuations have come down dramatically even though long-term demand for entertainment and consumer goods are expected to climb significantly over the next 10 years in China.
I would be glad to add both iQiyi and Alibaba to my portfolio, but if I had to choose one, I would rather buy Alibaba right now. It's profitable and growing fast, while iQiyi remains unprofitable as it reinvests in content to drive growth. That's not a negative for iQiyi, but in these uncertain times, Alibaba's $15 billion in free cash flow provides a cushion for the stock, whereas iQiyi is difficult for investors to value given its lack of profitability.
With Alibaba, investors can buy a share of one of the most dominant tech companies on the planet for about 24 times forward earnings estimates.
For all of these reasons, I believe Alibaba is the better buy for investors today.