Is iQIYI a Better Alternative for Netflix Investors?

Streaming players should be avoided unless they retract to a reasonable valuation; iQIYI looks like a better choice though

Author's Avatar
Jul 18, 2018
Article's Main Image

iQIYI Inc (IQ, Financial) is a technology company that belongs to the industry of internet information providers. The company is involved in the provision of online entertainment services in China. iQIYI follows a business model quite similar to that of Netflix (NFLX, Financial), which includes creation of original content, licensing of third-party content and distributing the entertainment content through its own platform. However, unlike Netflix, the China-based streaming service also allows its users to upload content to the platform.

iQIYI supports a multi-tier monetization model

iQIYI’s revenue is evenly distributed between subscription and advertising. The company reported total revenue of $777.6 million during the first quarter of 2018. Revenue from subscription came in at $334 million, increasing 67% year-over-year, while advertising revenue – which includes brand advertising and in-feed advertising – reached $336.5 during the first quarter, up 52%. Note that iQIYI also generates some of its revenue from sub-licensing its original content to external parties.

998844490.jpg

iQIYI is guiding for mid-point revenue of $943.1 million for the second quarter of 2018. If sequential growth remains intact, iQIYI is on its way to generate more than $4 billion in revenue during 2018.

What’s the thesis?

1. Positives

iQIYI supports a flexible monetization model that incorporates subscription, advertisement and royalties from partner accounts.

In contrast to the rigid monetization model followed by Netflix, iQIYI is monetizing its platform with subscription fees, online advertising services and revenue sharing with partner accounts – similar to YouTube Channels. iQIYI is actually a hybrid of YouTube and Netflix. On one hand, the company has the ability to provide ad-free content to its premium subscribers. On the other, it has the flexibility to earn from ads on non-exclusive content uploaded by users. In short, the company has a diverse monetization base, which makes it less prone to pricing risk like the ones faced by Netflix.

iQIYI is garnering attention as users are flocking towards the platform.

Since the IPO in April 2018, iQIYI’s platform has jumped from under 500 to 172 in global website rankings maintained by Alexa. IQIYI has become the 27th most visited website in China. What’s even more interesting is that the average time spent on iQIYI’s platform per user is almost double that of Netflix, according to Amazon’s analytics.

The subscriber opportunity in China is a massive one.

More than 700 million people in China have some kind of internet access. By the end of 2017, China Mobile – the largest telecom service provider of the mainland – had 650 million 4G subscribers and 113 million wire-line broadband subscribers. Moreover, China’s pay-TV subscribers are set to reach 375 million by the end of 2023, according to Statista. All in all, the addressable market is quite huge and beneficial for iQIYI given the fact that international players won’t be able to compete with iQIYI in China.

2. Negatives

Unlike the international market where Netflix is yet to face serious domestic competition in the streaming arena, domestic streaming competition is the primary threat for iQIYI in China.

“The subscription OTT market is starting to heat up in the country … the market is currently dominated by platforms operated by BAT—Baidu’s iQiyi, Alibaba’s Youku and Tencent’s Tencent Video. Though iQiyi currently leads the market, we expect the gap between the three platforms to narrow as investment continues and content strategies evolve,” said emarketers in a report on China’s streaming landscape.

More recently, iResearch – a market research company based in China – reported that Tencent Video has become the leading video streamer with 600 million monthly active users. In short, stiff competition is expected in the Chinese streaming market going forward.

Streaming is a content intensive business, which isn’t good news for iQIYI.

Thanks to rising competition, quality content is necessary to keep subscribers hooked to a given platform. This makes entertainment content provision a high-cost and low-margin business. For perspective, note that iQIYI reported $617 million in content costs during the first quarter of 2018 while generating revenue around $777 million. This means the company spent an astonishing 79% of its revenue of content. Similarly, 59% of Netflix’s revenue was offset by content costs during the second quarter of 2018. In short, entertainment is a content-intensive business, and low-cost subscription models are not feasible in the long run.

An additional problem for iQIYI is the lack of affluent population.

Netflix can manage to increase prices as U.S. based subscribers are less sensitive to pricing changes. In China, subscribers might abandon the IQIYI platform if the company raises prices to cover for content costs.

Final thoughts

Although China’s streaming market is booming and iQIYI is doing well in terms of growth, the presence of competition, high content costs and lack of buying power of consumers make it difficult to pitch a bull case for iQIYI. Other platforms including Tencent Video will fight for subscribers, resulting in even higher content costs and low margins in the business. There should not be any doubt about iQIYI’s ability to gain material subscribers going forward, but the company might not be able to do it as profitably as the stock price depicts.

Nonetheless, iQIYI is in a much better position than Netflix, both from a strategic perspective and a valuation perspective. Advertizing can provide wiggle room for the China-based streaming giant to fight for subscribers; this might not be the case for Netflix once Disney enters the market amid the rigid monetization strategy of the streaming giant.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.