Investors in online video streaming company iQIYI (IQ -5.41%) endured a roller-coaster ride in the last 12 months. Shares fell more than 40% from their February 2019 high of $29, before rallying by more than 60% to close above $25 recently. iQIYI will report its fiscal 2019 fourth-quarter results on Feb. 27. Let's recap its previous quarterly performance and look at three things investors should be watching closely in the next earnings report.
Online advertising business
iQIYI derives its revenue mainly from four areas-membership services, online advertising, content distribution, and others. Its online advertising business (the second-largest segment, accounting for 28% of revenue in the most recent quarter) faced significant challenges in 2019. In the second and third quarters of 2019, ad revenue declined by 16% and 14%, respectively, year over year. According to the company, this was mainly driven by "the challenging macroeconomic environment in China, the delay of certain content launches, and slower-than-expected recovery of our in-feed advertising".
Investors should pay attention to how iQIYI's online advertising business performs in the coming quarter to get a feel for how the business is coping with its challenges. Ideally, we hope to see revenue decline more slowly, or even improve, for the quarter.
Subscription revenue growth
iQIYI derives the bulk of its revenue from its membership subscription business. As of Sept. 30, 2019, total subscribing members reached 105.8 million, up 31% year over year.
The strong subscriber growth, driven by premium content and other initiatives, propelled subscription revenue up by 30% year over year in iQIYI's third-quarter 2019 results. Moreover, that strong performance overshadowed the other businesses' weakness, fueling whole-company revenue gains of 7% year over year.
Going forward, investors expect this part of the business to keep growing, especially considering that only 105.8 million of iQIYI's more than 550 million monthly active users have signed up for a subscription. We'll want to see the company sustain its pace in paid subscriber growth in the next earnings release.
iQIYI has been operating at a loss since its inception, with net losses hitting a high of $1.3 billion in fiscal 2018 because of its continuous investment in content. The company spent $3.1 billion on content against $3.6 billion in revenue in fiscal 2018. In the third quarter of 2019, higher operating costs and foreign exchange losses widened iQIYI's net loss further, from RMB 3.1 billion to RMB 3.7 billion ($516 million) year over year, despite its overall revenue growth.
For growth investors, such losses are probably acceptable, considering that the company is still in a growth phase. Yet they should note that iQIYI has been burning cash rapidly, and its continued losses mean that it will need new capital soon. If it keeps losing this much money each quarter, its $1.6 billion in cash and cash equivalents and short-term investments will last for less than a year.
In other words, investors should closely watch the company's operating cash flow and cash position in the earnings report. Any substantial rise in cash usage will be a red flag.
A word on share price volatility
For the fourth quarter of 2019, iQIYI expects to generate net revenues between $0.96 billion and $1.02 billion, representing a -2% to 4% increase from the same period in 2018.
This guidance probably assumes that membership revenue will keep growing (by around 30%, based on the previous quarter's result) while other businesses such as online advertising continue to post weaker performance. If actual revenue comes in at the higher end of expectations, investors might see the share price improve further. Any unexpected deterioration in operating losses or higher cash burn will likely weigh down the share price.
Long-term investors, however, should focus more on the company's business performance. Watch how well it sustains paid subscriber growth and manages cash flow, among other metrics. As a high-growth company still posting net losses, iQIYI's share price will likely remain volatile for the foreseeable future. Investors seeking tech stocks should be emotionally prepared to stomach those ups and downs before they buy into this company.