Volatility and stock markets go hand-in-hand. And the continuing U.S.-China trade wars has affected many shares negatively.
When fear prevails, logic can easily get thrown out of the window and many stocks decrease to price levels that make them much cheaper than they were several months ago. One such stock that has felt the squeeze recently is IQiyi (NASDAQ:IQ), the online streaming and entertainment company based in Beijing.
Since late February, IQ stock has fallen over 35%, from a 2019-high of $29.09 to a recent price of $18.25. In Mar. 2018, iQiyi, referred to by many as the “Netflix (NASDAQ:NFLX) of China” priced its U.S. initial public offering at $18. In other words, now that the share price is hovering around the IPO price, many investors are wondering whether they should buy IQ stock.
Although iQiyi stock will likely reward long-term investors for many years to come, it may nonetheless continue to be volatile over the next few weeks. And I do not expect a major favorable sentiment shift toward Chinese stocks in the near-term. Yet investors may see any further price declines as good opportunities to go long IQ stock. Here is why.
IQ Stock and Investing in the Growing Chinese Consumer Economy
IQ stock, a spin off from China’s search leader, Baidu (NASDAQ:BIDU), offers investors the enticing possibility of investing in the growing Chinese consumer economy. IQ was initially an ad-supported, video-on-demand service. Then in 2015, BIDU adopted Netflix’s pay-for-content subscription model to China and started charging about $3 per month for original content.
After the service grew, Baidu decided to spin it off and, subsequently, IQ stock had its IPO in March 2018. After Tencent Video, which is owned by Tencent Holdings (OTCMKTS:TCEHY), IQ is the second largest video platform. Extremely popular in China. IQ has one other main competitor — Alibaba‘s (NYSE:BABA) Youku Tudou — which is more like Alphabet‘s (NASDAQ:GOOG,NASDAQ:GOOGL) YouTube platform.
The online-video market is growing quickly in China, partly thanks to the availability of more mobile devices.
Thus, those who own IQ stock will be able to participate in the growing online video market in China, where the number of paying subscribers is expected to pass 300 million in 2019. IQ is well-positioned to capitalize on this trend. Additionally, many analysts expect IQ to expand into the rest of Asia.
How IQ Makes Money
On May 16, iQiyi reported its first-quarter earnings. Its revenue jumped 43% year-over-year and reached $1 billion. IQ has three main revenue streams.
- Subscription fees (Subscribers can view new, exclusive contents without ads);
- Advertising fees (Non-paying viewers must watch a 90-second advertisement before seeing any content);
- Content distribution fees (iQiyi receives these fees in exchange for licensing its original content).
In other words, IQ’s management has been building a rather diversified business model.
IQ reported a 58% YoY increase in its subscriber base, which reached 96.8 million, leaving many analysts more upbeat about iQiyi stock In Q1, IQ added 9.4 million new premium members. By comparison, Netflix has almost 150 million subscribers globally.
iQiyi generates close to one-third of its revenue from advertising. In fact, a majority of the estimated 1 billion monthly IQ viewers still use the free, ad-supported offering.
IQ is still growing quickly, and I expect its next several earnings report to show that its sales growth is around 20%. This increase in revenue is expected to trickle down to the company’s bottom line in a few years.
What Could Derail IQ Stock Further?
The company’s Q1 results showed an operating loss of $301.9 million with a negative operating margin of 29%. Its Q2 revenue guidance was also disappointing.
Management has underlined that as the company further invests in technology and expands its content library, its cost of revenue will be high. In other words, IQ will not be profitable anytime soon.
Analysts value IQ stock based on their belief that its revenue growth will continue to be strong, leading to profits in the future. Therefore, whenever Wall Street fears the company is failing to meet top-line or bottom-line expectations, IQ stock will get penalized.
In other words, long-term investors should be ready for daily price fluctuations as well as high volatility around earnings release dates.
In addition to stock-specific speculative moves,those considering buying IQ stock should also consider the current global trade wars and the state of the Chinese economy. Recently, the International Monetary Fund (IMF) has warned that China, the world’s second-biggest economy, has been slowing considerably.
If the Chinese economy stalls further, IQ’s advertising revenue could be impacted. Marketers in China have already been scaling down their ad budgets. At this point, Wall Street does not know if the ad slowdown will just prove to be a bump in the road for IQ stock or the trigger for a meaningful downturn in IQ’s business.
However, a potential cooling off of China’s economy shouldn’t impact anyone’s long-term investing strategy. And if IQ’s user base continues on its current growth trajectory, an advertising revenue decline probably won’t impact iQiyi stock much. Those who plan to hold IQ stock over the long-term are happy to bet that more Chinese viewers will be willing to subscribe to IQ’s services instead of watching ad-supported free content on the company’s website.
The Bottom Line on iQiyi Stock
For long-term investors, any near-term fluctuations of IQ stock will be negligible. Yet markets suffer during times of uncertainty and in the coming months, I expect IQ stock to be a battleground between investors and traders.
As a result, IQ stock price may have a bumpy ride, possibly until the company reports its Q2 earnings in August. When its Q2 results are released, long-term investors may want to re-evaluate its business outlook. Going forward, analysts would also like to see the company’s sales growth rise above the mid-teen level.
New investors may want to consider buying IQ if iQiyi stock goes below $17. IQ stock will become very attractive as it moves toward the $15 level.
The current owners of IQ stock may also consider hedging their positions. As for hedging strategies, covered calls or put spreads that expire on July 19 could be appropriate, as straight put purchases are likely to be expensive due to heightened volatility.
On a final note, Baidu still owns over 55% of IQ stock and about 20% of BIDU’s revenues come from IQ. Therefore, those investors who may not be ready to invest in IQ may consider buying BIDU stock. Such a move would give those investors exposure to iQiyi stock, too. Despite the choppy and weak price movements of IQ stock lately, iQiyi still has a large opportunity in the Chinese market.
As of this writing, author did not hold a position in any of the aforementioned securities.
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