Growth is slowing at iQiyi (NASDAQ:IQ), but don't be so quick to dismiss China's top dog in video streaming. There are certainly plenty of risks when folks invest in China stocks, but the juicy potential rewards are also there for the taking given the promising upside in the world's most populous nation.
iQiyi's reach is significant. There are now 105.8 million premium subscribers on the streaming platform, a whopping 31% increase over the past year. Yet there are some big hurdles for iQiyi to clear. Losses continue to mount given the high content and bandwidth costs. Online advertising is also a revenue stream that's been muddied up with China's slowing economy. However, there is still plenty to like in iQiyi for patient and risk-tolerant investors. Let's hit play and see where this goes.
The top line has slowed dramatically at iQiyi this year. After five quarters of 40% to 48% in revenue gains, growth slowed to 15% in the second quarter, only to be cut in half for this month's latest report.
Revenue climbing a mere 7% in the third quarter might seem shocking at first glance, particularly in light of the 31% surge in subscriptions. However, this is the result of a 30% increase in membership services -- accounting for a little more than half of the total revenue mix -- held back by double-digit-percentage slides in online advertising and content distribution revenue.
The shares still moved higher on the earnings news, and iQiyi is trading 21% higher so far this year despite the sharp deceleration in revenue and no signs of near-term profitability. Investors can appreciate iQiyi's model shifting from the volatile ad-supported platform it was primarily known for a few years ago to one in which steady and predictable subscription revenue is the top driver.
Investors appreciated iQiyi's latest financial update, but analysts were divided. Two Wall Street pros that were neutral on the stock heading into the third-quarter release took divergent paths last week. UBS upgraded the stock to buy following the report, but 86 Research downgraded the shares to sell.
This would seem to be a bad time to give up on iQiyi. There's only one other streaming video service on the planet that has cracked nine figures when it comes to premium subscriptions, but we can't forget that it's not the only way that folks are doing business with iQiyi. The online advertising market in China won't stay in a funk forever -- a bigger catalyst than you might think since iQiyi reaches more than 400 million monthly active users on mobile and another 400 million monthly active users on PC who mostly put up with ads to catch free content. There's also a shift in the mobile market to 5G, an infrastructure upgrade that should encourage more video consumption on smartphones.
Profitability is still at least three years away, but there's no reason to think that iQiyi's popularity won't continue to expand between now and then. Just as we're seeing closer to home, content producers are warming up to iQiyi as a distribution platform with its widening reach.
Contrarians will also warm up to the fact that there were 56 million shares of iQiyi sold short by the end of last month. The number of naysayers betting against iQiyi has been slightly higher in the past, but with trading volume slowing, we've never seen the short ratio -- the number of shorted shares divided by average daily trading volume -- as high as it is right now. Put another way, the stock's spike following this month's mixed report could be the first of many short squeezes that push iQiyi higher. The fundamentals might not be at their best right now, but the catalysts are there for iQiyi to rise again in 2020.