iQiyi's (NASDAQ:IQ) stock recently surged after Reuters claimed Tencent (OTC:TCEH.Y) could buy a major stake in the video streaming giant. Baidu (NASDAQ:BIDU) spun off iQiyi in an IPO two years ago, but maintains a 56.2% stake in the company.
iQiyi and Tencent Video are the two largest subscription-based streaming video platforms in China. iQiyi served 119 million subscribers last quarter, while Tencent Video reached 112 million subscribers.
Reuters' initial report, which cited two unnamed sources, claimed Tencent's could replace Baidu as iQiyi's largest shareholder. But Baidu's PR director Guo Feng subsequently announced the company would still support iQiyi's development, and the platform would remain a key part of its content strategy.
Feng didn't directly address the investment rumors, but his statement suggests Baidu might not surrender control of iQiyi to Tencent. However, Tencent could still possibly buy a significant stake in iQiyi -- which could cut costs by reducing competition and sharing content between the two platforms.
Those synergies could help iQiyi, which has bled red ink for years, finally turn a profit. The investment could also help Tencent dominate China's online video market and widen its moat against top rivals Alibaba (NYSE:BABA) and ByteDance.
Understanding Tencent's streaming media ambitions
Tencent generates most of its revenue from online games, online ads, and its business and fintech services, which include Tencent Cloud and WeChat Pay.
Last quarter, Tencent generated 58% of its revenue from value-added services (VAS), which include in-game purchases and paid subscriptions for Tencent Video and Tencent Music (NYSE:TME), the largest music streaming company in China.
Tencent's total VAS revenue rose 27% year-over-year during the quarter, as the COVID-19 crisis and social distancing measures boosted in-game spending and streaming subscriptions. Tencent Video's total subscriptions grew 26% annually, buoyed by the releases of new Chinese drama and anime series, as Tencent Music's subscriptions jumped 50%.
Tencent's media advertising revenue, which accounted for just 3% of its top line, fell 10% annually as macro headwinds and the suspension of live sports curbed ad purchases aimed at its free ad-supported streaming users. Merging Tencent Video's free users with iQiyi's would create a larger advertising platform with more pricing power.
Taking control of iQiyi would complement Tencent's other moves
Tencent's previous media moves also indicate it would prefer to take control of iQiyi instead of remaining a minority stakeholder subservient to Baidu.
Back in 2016, Tencent created Tencent Music by merging three of China's most popular music streaming platforms -- QQ Music, Kugou, and Kuwo. That combined ecosystem served 657 million mobile monthly active users (MAUs) last quarter.
Tencent also owns significant stakes in two of the world's three largest record labels, Universal and Warner Music, while the third -- Sony Music -- owns a stake in Tencent Music. Those tight partnerships enable Tencent Music to secure favorable royalty rates, and allow it to sub-license its songs to competing streaming media platforms.
Tencent also owns major stakes in Huya (NYSE:HUYA) and DouYu, the two largest e-sports streaming platforms in China. Tencent replaced JOYY as Huya's majority stakeholder earlier this year, which sparked speculation it could merge the two platforms into a single market-leading platform like Tencent Music.
In that context, it makes sense for Tencent to wrestle control of iQiyi away from Baidu. A combination of the two platforms would tower above Alibaba's Youku Tudou -- which ranks third behind iQiyi and Tencent Video -- and bolster its clout in royalty negotiations with content providers.
The strength of a combined Tencent Video/iQiyi ecosystem would also shore up Tencent's defenses against ByteDance, which is disrupting the online video market with its viral short video app TikTok (known as Douyin in China).
But it's all speculation for now...
Tencent's takeover of iQiyi could be a game-changer for China's online video market, but it's unclear if Baidu -- which still relies on iQiyi for most of its revenue growth -- will let go of the subsidiary. Therefore, investors should simply monitor the situation instead of aggressively scooping up shares of iQiyi and betting on a takeover.