U.S. Markets closed

Right Now the Future Looks Pretty Bleak for IQ Stock

Ian Bezek

While the U.S. stock market is making fresh new highs, Chinese firms are not enjoying the fun. Chinese stocks remain mired in a bear market, and its tech companies are in a drastic slump. Not surprisingly, iQiyi (NASDAQ:IQ) hasn’t been spared. In fact, IQ stock has lost more than half of its value over the past year.

IQ Stock

Source: Shutterstock

Much of this is probably due to external factors. The trade war has scared American investors away from Chinese stocks in general. And China’s economy is showing signs of strain. But iQiyi has some concerns of its own that could keep the stock in the doghouse in coming months.

Is iQiyi To Fault For Its Massive Stock Price Losses?

Chinese stocks have gotten absolutely hammered over the past year. There are 39 Chinese firms with a market cap over $2 billion that have been listed in the U.S. for at least a year.

InvestorPlace - Stock Market News, Stock Advice & Trading Tips

Of these, 24 (well more than half ) have lost at least 20% of their value over the past year. Only four out of the 39 have posted a positive return over the past year.

IQ stock has been the biggest loser of the bunch, however, shedding 59 percent of its value over the past 12 months. Other notable peers have performed almost as bad, however.

Weibo (NASDAQ:WB) is down 58 percent. Sina (NASDAQ:SINA) has plunged 52 percent. And even internet giant Baidu (NASDAQ:BIDU) hasn’t been spared; it has knifed 55 percent lower. So IQ stock, while being the worst of a sorry bunch, is hardly an overwhelming outlier.

iQiyi’s Recent Tumble

Like most tech stocks, IQ plummeted to end 2018. Shares recovered to start 2019, but that recent optimism faded in March. Since then, IQ stock has been going straight down again.

In addition to the general concerns about the trade war and the health of the Chinese economy, iQiyi is facing two more direct concerns.

The first of these is increased government regulation. The China National Radio and TV Administration “NRTA” recently issued more strict guidelines for China’s major video players. These will sharply limit the amount of historical dramas that these companies can produce, in relation to dramas based on modern settings.

The Chinese government suggested that the video companies were promoting false and harmful views of China’s past with these dramas.

While this may sound like a silly issue to western investors, it is something to take seriously. Even the most hyper-capitalist of companies must play by a different set of rules in China than they would in places that have more free speech protections.

Additionally, it’s worth noting that various other Chinese media companies listed in the U.S. have gotten in trouble with the Chinese government for concerns ranging from piracy to sexual content previously, causing sizable share price declines. The current issue with historical dramas will probably blow over. But IQ stock will always face the headwind of the possibility of a government content crackdown at any point.

iQiyi also issued more than $1 billion in convertible bonds in March. At the time, it appeared to be a success for IQ stock. They raised money at a lower interest rate and at a less dilutive price than expected. It also represented the second largest convertible bond offering by a Chinese firm in the United States to date.

Still, it also appears to have reminded investors that iQiyi has a troubling balance sheet and no plans to make profits anytime soon.

When Will iQiyi’s Business Model Turn The Corner?

It’s popular to refer to iQiyi as the Netflix (NASDAQ:NFLX) of China, but this analogy doesn’t fully work. For one thing, Netflix relies almost exclusively on subscription revenues. iQiyi, by contrast, gets less than half of its revenues from paid subscriptions. At its price points of $3/month for monthly subscriptions and $2/month for annual subscriptions, iQiyi needs a whole lot of subs to turn a profit.

Notably, iQiyi doesn’t have the first mover advantage that Netflix did. Already, the Chinese market has three major players. iQiyi has more than 500 million monthly users (not subs), but so does Tencent’s offering. Alibaba’s (NYSE:BABA) Youku has more than 400 million as well.

They all offer competitively subscriptions at super low price points. This makes it difficult for iQiyi to simply copy the Netflix model of raising the subscription price frequently.

On the other hand, iQiyi shares a major similarity with Spotify (NYSE:SPOT) rather than Netflix. This is that it has a robust free option, and generates substantial advertising revenues from it.

iQiyi, like Spotify, hopes free users will upgrade over time, but it’s not a completely closed community like Netflix. Advertising, though down as a percentage of the pie, still made up 43% of iQiyi’s revenues in 2018, with subscriptions at just 37%.

The idea is that iQiyi will eventually have enough original content to be able to drive far more subscription revenue. At this point, iQiyi is spending nearly as much on content costs as it brings in in revenue. That’s obviously not a sustainable model.

The question is, will iQiyi be able to reach an inflection point where it starts earning a profit on its content? The fact that two well-funded rivals in Alibaba and Tencent oppose them make it very difficult to either lock up the market or raise prices aggressively.

IQ Stock Verdict

If iQiyi can stay the course for quite a few years, it can become a huge winner. It trades far cheaper than Netflix and other streaming companies on a Price/Sales basis. The combination of aggressive revenue growth and an expanding valuation multiple could make IQ stock a home run.

But it will be many years, if ever, until iQiyi reaches that point. Right now, the business is losing gushers of money. That’s problematic as it faces entrenched rivals. How long will investors fund iQiyi’s money-burning content strategy? If the company can keep adding subscribers quickly, IQ stock will eventually recover. But there’s a decent chance it will continue to struggle for a long time to come.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.

More From InvestorPlace

The post Right Now the Future Looks Pretty Bleak for IQ Stock appeared first on InvestorPlace.