Summary
- Concerns regarding iQIYI's refinancing risk have eased considerably after the company raised almost $1 billion from recent fundraising activities.
- I am impressed with IQ's key metrics relating to price increases, subscriber growth, content costs, and profit margins.
- My rating for iQIYI is a Buy, as I have a favorable view of IQ's recent developments, and its current valuation multiples are appealing, considering historical and peer comparisons.
Elevator Pitch
I assign a Buy investment rating to iQIYI, Inc.'s ( IQ ) shares. My positive opinion of IQ is supported by recent favorable developments such as the successful capital raising deals and price increases for its membership subscription. iQIYI's valuations are also undemanding as compared to peers and its own historical trading averages.
Company Description
iQIYI describes itself as "a leading provider of online entertainment video services in China" on the company's investor relations website . IQ is also often referred to as "China's Netflix ( NFLX )" by the media . Chinese internet giant Baidu ( BIDU ) is iQIYI's parent with a 53% equity interest.
In the most recent Q3 2022 financial period, IQ earned 56% of its revenue from membership services. Online advertising services, content distribution, and others (e.g. live streaming, games, etc.) accounted for the remaining 17%, 10%, and 17% of iQIYI's top line, respectively in the third quarter of last year.
Recent Fund Raising Activities
iQIYI recently disclosed on January 19, 2023 that the company has raised $442.3 million in fresh funds from the completion of the "public offering of 76,500,000 American Depositary Shares" or ADS "at a public offering price of $5.90 per ADS." Earlier on January 3, 2023, IQ revealed that it had concluded "a private placement of $500 million in secured convertible senior notes" to an institutional investor known as PAG.
IQ's recent fund raising activities have helped to ease the market's concerns about the company's financial position. As indicated in the company's fiscal 2021 20-F filing , iQIYI had $1.2 billion of "convertible senior notes due 2025" for which holders have the right to demand IQ to "repurchase all or portion of the 2025 Notes for cash on April 1, 2023." Given that iQIYI has successfully raised close to $1 billion in January this year, the company's refinancing risk has been reduced to a very large extent.
The positives relating to the mitigation of IQ's short-term refinancing risk haven't been fully priced into the company's shares.
IQ's shares have done pretty well recently after the company completed its recent fund raising activities. In the past one month, iQIYI's stock price rose by +26% as compared to a more modest +8% rise for the S&P 500 in the same time period. But IQ's current valuations are still pretty attractive as compared to history and peers.
iQIYI currently trades at consensus forward next twelve months' Enterprise Value-to-Revenue and normalized P/E multiples of 2.0 times and 23.9 times, respectively. As per S&P Capital IQ's valuation data, IQ's three year mean forward EV-to-Revenue multiple was relatively higher at 2.3 times, while NFLX is now valued by the market at a more demanding 32.1 times forward P/E.
In my opinion, there is room for IQ to experience further valuation multiple expansion, considering the company's increased focus on original content and its good expense management.
Original Content
IQ highlighted at the company's Q3 2022 earnings briefing on November 22, 2022 that 65% of the dramas rolled out by iQIYI in the third quarter of the prior year "were original content" and represented "a historic high."
The success of iQIYI's strategy of growing original content is validated by two key metrics.
The first key metric is pricing. IQ has managed to implement three price hikes since the end of 2020; the cost of acquiring an iQIYI membership has jumped by approximately 67% in absolute terms in this time period. IQ's pricing power serves as the best form of validation that Chinese consumers appreciate the value of iQIYI's original content. The company's most recent price hike was initiated in December 2022 according to local Chinese media .
The second key metric is subscriber growth. The number of subscribers for iQIYI grew by an impressive +11% QoQ from 95.6 million as of the end of the second quarter of last year to 106.2 million as of end-Q3 2022. The meaningful increase in subscribers for IQ in Q3 2022 is closely linked to the company's focus on original content. Notably, iQIYI mentioned at its Q3 2022 investor briefing that its "top 3" dramas for the third quarter of the previous year were original content.
Expense Management
Q3 2022 marked the second quarter running that IQ had managed to deliver positive operating cash flow. Based on the consensus financial projections sourced from S&P Capital IQ , the sell-side analysts expect iQIYI's operating cash flow to jump from RMB235 million for FY 2022 to RMB2,304 million in FY 2023, before rising further to RMB3,644 million in FY 2024.
At its Q3 2022 results call, iQIYI specifically discussed about the company's "Calm Growth strategy", which places a strong emphasis on "ensuring overall operating efficiency, enhancing content investment and marketing spending in an appropriate manner."
The good progress that IQ has made in optimizing its cost structure with its "Calm Growth strategy" is reflected in the company's financial numbers. Content costs for iQIYI declined by -18% YoY to RMB4.3 billion in Q3 2022. IQ's gross margin expanded significantly from 7% in Q3 2021 to 24% for Q3 2022, while it turned around from an operating loss to achieve a 7% operating profit margin in the same time frame.
Closing Thoughts
I rate IQ's stock as a Buy. iQIYI's shares have the potential to rise further, as its current valuations have yet to completely factor in the company's success with its original content, excellent cost management initiatives, and the reduced refinancing risk.
For further details see:
iQIYI: Successful Fund Raising And Price Hikes Are Positive Developments