iQiyi's (NASDAQ:IQ) stock recently plunged to a six-month low after it priced an $800 million convertible debt offering and a new ADS (American Depositary Share) offering of 40 million shares. Both transactions are expected to close by Dec. 21.

Its $800 million offering in convertible notes, which will mature on June 15, 2026, bears an annual interest rate of 4%. On or after that maturity date, those notes can be converted at any time to 44.8179 shares per $1,000 in principal -- which equals a conversion price of about $22.31 per ADS.

On Aug. 1, 2024, those investors can ask iQiyi to repurchase "all or part" of their notes for 100% of the principal value -- which sounds like a safety net for investors who are concerned iQiyi's ADS could be worth less than $22.31 per share by the maturity date.

A businessman peers over the edge of a declining stock chart.

Image source: Getty Images.

iQiyi then priced its new offering of 40 million shares at $17.50 per ADS, which was actually lower than its IPO price of $18 per share back in 2018. That offering, which could raise $700 million, will dilute iQiyi's stock by boosting its number of outstanding shares by about 5%.

iQiyi claims the combined proceeds of about $1.5 billion will be used to "expand and enhance its content offerings, strengthen its technologies, and for working capital and other general corporate purposes." It isn't surprising to see iQiyi invest more cash into its streaming video ecosystem, but the latest offerings also raise bright red flags about its struggling business.

Reviewing iQiyi's problems

iQiyi is one of China's largest freemium video streaming platforms. Its top competitors are Tencent (OTC:TCEHY) Video and Alibaba's (NYSE:BABA) Youku Tudou. Last quarter, it generated 56% of its revenue from paid subscriptions, 25% from ads, and the rest from other businesses -- including content licensing fees from other broadcast platforms.

iQiyi's growth in revenue and paid subscribers decelerated significantly over the past year, even after the pandemic caused users to stream more content in the first half of the year.

Growth (YOY)

Q3 2019

Q4 2019

Q1 2020

Q2 2020

Q3 2020

Revenue

7%

7%

9%

4%

(3%)

Paid Subscribers

31%

22%

23%

4%

(1%)

YOY -Year-over-year. Source: iQiyi.

iQiyi blamed that slowdown on a shortage of new content during the pandemic, competition from rival platforms, users spending more time on short video apps like ByteDance's Douyin (known as TikTok overseas), and a shorter summer vacation.

iQiyi also remains unprofitable, and its losses are weighing down the margins of its parent company Baidu (NASDAQ:BIDU), which has already been struggling with a slowdown in its core advertising business over the past year.

Baidu could be cutting iQiyi loose

Earlier this year, Tencent and Alibaba were reportedly interested in buying a majority stake in iQiyi. That sale would have allowed Baidu to gracefully exit the saturated streaming video space, boost its margins, and raise fresh cash for more promising investments and acquisitions.

However, China's State Administration for Market Regulation (SAMR) recently passed new antitrust rules and fined Alibaba and Tencent for failing to properly report some recent acquisitions.

The agency now requires any mergers that generate over 2 billion yuan ($310 million) annually in China or 10 billion yuan ($1.5 billion) globally to receive government approval. iQiyi is expected to generate about $4.6 billion in revenue this year, so a mega-merger between iQiyi, Tencent Video, and Youku Tudou is likely off the table for now.

Faced with this sudden shift, Baidu, which previously covered many of iQiyi's operating expenses, likely pushed its streaming subsidiary to do more of the heavy lifting on its own.

However, iQiyi's own cash and equivalents fell 30% year over year to 3.16 billion yuan ($480 million) last quarter, and its free cash flow (FCF) only improved slightly from negative 2.58 billion yuan ($390 million) to negative 2.02 billion yuan ($310 million). Therefore, iQiyi needs a quick way to raise some cash -- and a $1.5 billion debt and share offering seemed to be the answer.

Should investors be concerned?

This marks iQiyi's third convertible debt offering in just two years, following its $750 million offering in late 2018 and its $1.2 billion offering in early 2019.

As a result, iQiyi ended last quarter with 35.4 billion yuan ($5.4 billion) in total liabilities, including 20.5 billion in current liabilities and 14.9 billion yuan in non-current liabilities. That gives it a whopping debt-to-equity ratio of 6.6 -- up from 3.6 a year earlier.

Adding $800 million in convertible notes to that pile could easily push that ratio above 7.5. By comparison, Netflix (NASDAQ:NFLX), which is firmly profitable, ended last quarter with a much lower debt-to-equity ratio of 2.7.

It's unclear how iQiyi will ever reduce that growing mountain of debt when its struggling core business remains unprofitable. Simply put, these latest offerings, along with Baidu's rumored interest in selling the company, strongly suggest iQiyi is becoming a dangerously unstable investment.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.