U.S. Markets closed

Why Momo and iQIYI Had Very Different Fates in the First Half of 2019

Nicholas Rossolillo, The Motley Fool

Gone are the days of high-in-the-sky revenue growth for Momo (NASDAQ: MOMO) and iQiyi (NASDAQ: IQ), but China's middle class continues to develop, and disposable income is on the rise. That means these two Chinese entertainment stocks still have plenty of runway left.

However, shares of Momo and iQiyi have headed in different directions this year. While Momo has seen a 54% rally in 2019 year to date, iQiyi has reversed course after a big early-year gain and is now up "only" 19% for the year. Both businesses continue to grow their top line, but it's the way they're doing it that's making all the difference.

MOMO Chart

Data by YCharts.

iQiyi is growing but at a cost

iQiyi, backed and majority-controlled by Baidu (NASDAQ: BIDU), reached a milestone during the second quarter of 2019: It surpassed 100 million subscribers, a 50% year-over-year increase. The "Netflix of China" powers its platform with artificial intelligence, helping viewers choose from a massive library of self-produced, third-party, and user-generated content.  

While new subscribers have contributed a healthy dose of top-line expansion, other areas of the business haven't fared so well. Advertising revenue fell 16% during the second quarter, and content distribution increased a meager 4%. Management was quick to cite the trade war and a resulting slowdown in the Chinese economy. But the end result is the same: Revenue in the first half of 2019 came in only 28% higher than the year prior.  

Big deal, right? Most companies would love to post expansion rates anywhere close to 28%. But iQiyi still runs at a loss -- both on an adjusted and unadjusted basis -- and operating expenses climbed higher (34%) than revenue did through the first six months of the year. All told, it tallied up to a net loss of RMB 4.14 billion, compared with a loss of RMB 2.79 billion in 2018. Ouch!  

The slowdown is expected to continue, with revenue forecast to be 4% to 10% higher in Q3 and operating expenses continuing to soar as iQiyi keeps adding content to keep viewers coming back. It's not a pretty picture, and while the TV streamer is amply funded and has the backing of China's search giant Baidu, investors have been none too pleased with the outlook for pedestrian sales and steepening losses.  

A line of people sitting on a bench using laptops, tablets, and smartphones.

Image source: Getty Images.

Meanwhile, Momo backs the truck up to the bank

Dating app and general entertainment company Momo has also been cooling off. After posting 48% revenue growth in 2018, first-quarter 2019 revenue came in at 35%. Second-quarter sales slowed again, to 32%, but it was still better than the 27% to 30% management had forecast.

Momo is best known for its matchmaking services -- akin to those offered by Match Group -- but it's expanding its ecosystem of apps to include other entertainment like video and games. And here's the key difference from iQiyi: Momo's core business, which boasts 113.5 million monthly users, is highly profitable and can thus fund its expansion without dipping into the red. That has kept shareholders more than content as even the slowdown at Momo (revenue is expected to be up 17% to 19% year over year in Q3) is far less severe than what other Chinese companies are suffering at the moment.  

In fact, Momo is so profitable that even its bottom line is growing despite its heavy pace of investing. Adjusted earnings grew to RMB 2.15 billion through the first half of 2019, compared with RMB 1.80 billion a year ago. Spending is certainly happening, but the cash is nevertheless flowing strong.  

This cheaper operating model and ability to expand without reaching deep into its coffers looks like a winning strategy, one that has sent Momo's stock price soaring this year in spite of ongoing concerns with the Chinese economy. Growth at a reasonable price? Investors are saying, "Yes, please."

Don't get tangled in the weeds

It might be easy to dismiss iQiyi based on the recent numbers, but it likely has just as bright a future as Momo. The economy in China at the moment could certainly be better, and the fact that both companies have been able to keep growing -- albeit at a slower pace -- is impressive. Business will likely rebound at some point, and let's not forget that iQiyi's 100 million subscribers and Momo's 113 million mean there's plenty of room to keep going, since China has a population of nearly 1.4 billion.

Besides, there's also the disposable-income part of the investment thesis for both businesses. China's middle class is still developing and accumulating wealth along with the overall economy, which means more money is likely to be spent on entertainment as time goes on. iQiyi and Momo both stand to benefit in the long haul.

Don't get me wrong: I favor Momo's profitable operating model much more so than iQiyi's. But while the two Chinese stocks have been on diverging courses as of late, don't be quick to dump either one for the other. Both still look like solid bets on the greater Chinese economy.

More From The Motley Fool

Nicholas Rossolillo and his clients have no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Baidu, Match Group, and Netflix. The Motley Fool recommends iQiyi and Momo. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com