IQiyi Earnings: Sales Growing Fast, Costs even Faster
iQiyi, the Netflix/YouTube hybrid in China, reported its 4th quarter and full year 2018 earnings after the bell on Thursday. It is typically at this point in an earnings article when the author regurgitates whether the stock beat or missed analyst expectations. I don’t know and don’t care about what analysts were expecting iQiyi to do. Arbitrary benchmarks like estimates disproportionally skew investor opinions and make people focus on the wrong things.
With that aside, here are the most important numbers from the full fiscal year:
Revenue of $3.6 billion, up 52% Y/Y, giving them a P/S in the 4-5 range.
Net loss of $1.3 billion, up 2.5x from 2017
87.4 million subscribers at EOY 2018, up 72% Y/Y
When looking at this stock, I see superb numbers (like subscriber growth) and concerning numbers (like a huge net loss number). I’ve written before how bullish I am about iQiyi’s potential, and we do own the stock in the MMP. That being said there are some big risks and potential red flags with this stock that need to be addressed.
Apparently shows like Yanxi Palace have been extremely successful for iQiyi.
What I Like
The number one thing I pay attention too when looking at iQiyi is subscriber growth, and they have been hitting it out of the park. A 72% growth rate is huge, especially at 87.4 million users. This is a slow-down from last quarter’s 90%, but still a very respectable number. Here is a table of what their subscriber numbers will look like a few years down the line based on different CAGRs.
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*All numbers are in millions.
Do I think iQiyi has any chance of getting 1.6 billion subscribers in five years? Probably not. However, I do think people underestimate the enormity of the Chinese market. For reference, Tencent Music has over 800 million monthly-active-users and is a young company backed by a tech giant just like iQiyi.
From a fundamental perspective the stock looks overvalued, but it is impossible (and quite stupid) to evaluate an early-stage tech platform the same way you would a 1950’s industrial stock. The easiest comparison to iQiyi is Netflix, so that is who we are going to look at.
The American streaming company has a P/S ratio twice the size of iQiyi, which doesn’t make sense to me. Netflix’s market cap is 10 times as big (over $150 billion) but only has 1.6 times as many subscribers. Obviously Netflix subscribers pay more, but do they deserve this much of a premium? I don’t think so.
What I Don’t Like
Two things concern me when looking at iQiyi’s balance sheet and income statement: the cost of revenue and cash on the balance sheet.
In 2018 revenue costs grew 65% to $3.9 billion, meaning that right now iQiyi has a negative gross margin. Costs are also growing faster than sales, which in the long run cannot be sustainable. This would be more concerning except for the fact $3.1 billion of the revenue costs came from content spending. From what I’ve seen this makes them the 3rd largest spender on content in the world behind Netflix and Amazon.
Another thing that concerns me is cash and cash equivalents. They only have $1.9 billion on the balance sheet and lost $1.3 billion in 2018, which you can easily see is unsustainable. Some combination of margin improvement and cost-cutting will have to happen in 2019 or iQiyi will be close to running out of money. Remember they are a Baidu subsidiary, an important connection if they ever get into a cash crunch.
I liked but didn’t love this report. Sales and subscribers are rising, but so are costs. Eventually, investors need to ask themselves: Is iQiyi getting a good ROI on their content spending? Right now I still think so. The huge upside outweighs the potential downside, and as long as this torrid growth continues I see few reasons why this company cannot succeed.
Disclosure: The author is not a financial adviser, and may have an interest in the companies discussed.