IPOs and Catalysts/Events, Global Equity Research Ltd

Arun George

IPOs and Catalysts/Events

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Global Equity Research Ltd

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iQIYI filed for a Nasdaq IPO to raise $1.5 billion on 27 February. It is a leading Chinese online video platform backed by <a href="https://www.smartkarma.com/entities/179" target="_blank" data-smartkarma-citation="entities:179:1">Baidu Inc (ADR) (BIDU US)</a>, a 69.6% controlling shareholder and <a href="https://www.smartkarma.com/entities/24409" target="_blank" data-smartkarma-citation="entities:24409:1">Xiaomi Corp (XIAOMZ CH)</a>, an 8.4% shareholder.This note updates <a href="https://www.smartkarma.com/insights/iqiyi-ipo-preview-likely-to-remain-a-not-for-profit" target="_blank">our previous note</a> with data from the SEC F-1 filing. We remain bearish on iQIYI on a fundamental basis. The Chinese online video platform market is structurally unprofitable due to fierce competition, low subscription prices and rising content costs. We believe that iQIYI will struggle to generate shareholder value due to:<ol class=""><li>The careful management of content costs is crucial to delivering sustainable and profitable growth. Investment in content has a direct bearing on subscription revenue and to some extent on online advertising revenue. Even the best-case scenario that iQIYI’s advertising revenue arises solely due to content investment, iQIYI’s content cost as a percentage of advertising and subscriber revenue was 86% in 2017. In comparison, Netflix International’s content cost as a percentage of revenue was 68% in 2017. However, this measure masks iQIYI’s real costs of acquiring subscribers.</li><li>iQIYI’s content cost as a percentage of subscriber revenue marginally declined from 200% in 2016 to 193% in 2017. In other words, iQIYI is spending $2 on content for every dollar in subscriber revenue. In contrast, Netflix International spends $0.68 on content for every dollar in subscriber revenue.</li><li>iQIYI is stuck in a vicious cycle of content costs exceeding subscriber revenue. First, despite stiff competition, iQIYI seems to be underspending on content. iQIYI’s content costs accounted for 59% of operating expenses in 2017 vs 71% for <a href="https://www.smartkarma.com/entities/20451" target="_blank" data-smartkarma-citation="entities:20451:1">Netflix Inc (NFLX US)</a>. Second, iQIYI along with competitors, have high churn rates around 70%. Third, the subscription prices in China are relatively low. We estimate that iQIYI would need to increase its monthly subscription price by 70% solely to breakeven on P&amp;L content costs.</li><li>iQIYI will likely require external funding for the foreseeable future. iQIYI has negative free cash flow (FCF) over the last three years due to increasing content costs. In addition, iQIYI has a worse FCF profile than Netflix with iQIYI’s FCF as a percentage of revenue -35% in 2017 vs -17% for Netflix.</li></ol>We will provide a view of valuation once the IPO price range is announced.

iQIYI filed for a Nasdaq IPO to raise $1.5 billion on 27 February. It is a leading Chinese online video platform backed by Baidu Inc (ADR) (BIDU US), a 69.6% controlling shareholder and Xiaomi Corp (XIAOMZ CH), an 8.4% shareholder.This note updates our previous note with data from the SEC F-1 filing. We remain bearish on iQIYI on a fundamental basis. The Chinese online video platform market is structurally unprofitable due to fierce competition, low subscription prices and rising content costs. We believe that iQIYI will struggle to generate shareholder value due to:The careful management of content costs is crucial to delivering sustainable and profitable growth. Investment in content has a direct bearing on subscription revenue and to some extent on online advertising revenue. Even the best-case scenario that iQIYI’s advertising revenue arises solely due to content investment, iQIYI’s content cost as a percentage of advertising and subscriber revenue was 86% in 2017. In comparison, Netflix International’s content cost as a percentage of revenue was 68% in 2017. However, this measure masks iQIYI’s real costs of acquiring subscribers.iQIYI’s content cost as a percentage of subscriber revenue marginally declined from 200% in 2016 to 193% in 2017. In other words, iQIYI is spending $2 on content for every dollar in subscriber revenue. In contrast, Netflix International spends $0.68 on content for every dollar in subscriber revenue.iQIYI is stuck in a vicious cycle of content costs exceeding subscriber revenue. First, despite stiff competition, iQIYI seems to be underspending on content. iQIYI’s content costs accounted for 59% of operating expenses in 2017 vs 71% for Netflix Inc (NFLX US). Second, iQIYI along with competitors, have high churn rates around 70%. Third, the subscription prices in China are relatively low. We estimate that iQIYI would need to increase its monthly subscription price by 70% solely to breakeven on P&amp;L content costs.iQIYI will likely require external funding for the foreseeable future. iQIYI has negative free cash flow (FCF) over the last three years due to increasing content costs. In addition, iQIYI has a worse FCF profile than Netflix with iQIYI’s FCF as a percentage of revenue -35% in 2017 vs -17% for Netflix.We will provide a view of valuation once the IPO price range is announced.

IQIYI IPO Update: Still Likely to Remain a Not-For-Profit

iQIYI is a leading Chinese online video platform, backed by <a href="https://www.smartkarma.com/entities/179" target="_blank" data-smartkarma-citation="entities:179:1">Baidu Inc (ADR) (BIDU US)</a>, an 80.5% shareholder. In its 4Q17 results on 13 February, Baidu detailed that iQIYI submitted a draft registration statement to the SEC for an IPO. According to press reports, iQIYI is seeking to raise $1 billion by the end of 1Q or early 2Q18.Overall, we are cautious on the upcoming iQIYI IPO. The Chinese online video platform market is structurally unprofitable due to fierce competition, low subscription prices and rising content costs. In China, the main online video platforms are moving away from a YouTube type advertising revenue model to a <a href="https://www.smartkarma.com/entities/20451" target="_blank" data-smartkarma-citation="entities:20451:1">Netflix Inc (NFLX US)</a> type subscription revenue model.Deep-pocketed parent companies such as <a href="https://www.smartkarma.com/entities/26" target="_blank" data-smartkarma-citation="entities:26:1">Tencent Holdings Ltd (700 HK)</a> and <a href="https://www.smartkarma.com/entities/787" target="_blank" data-smartkarma-citation="entities:787:1">Alibaba Group Holding Ltd (BABA US)</a> can justify the ongoing funding of their online video subsidiaries as part of a broader strategy of generating shareholder value through a cross-media IP strategy. However, for independently run companies such as iQIYI post-IPO, it will be challenging to generate shareholder value due to:<ol><li>The careful management of content costs is crucial to delivering sustainable and profitable growth. We estimate that iQIYI’s content cost as a percentage of subscriber revenue averaged 260% over the last three years. In other words, iQIYI is spending $2.60 on content for every dollar in subscriber revenue. In contrast, Netflix International spends $0.70 on content for every dollar in subscriber revenue.</li><li>iQIYI is stuck in a vicious cycle of content costs exceeding subscriber revenue due to four factors. First, despite stiff competition, iQIYI seems to be underspending on content. We estimate that iQIYI’s content costs accounted for 47% of operating expenses in 2017 vs 71% for Netflix. Second, iQIYI along with competitors, have low user retention rates of around 33%. Third, the subscription prices in China are relatively low. We estimate that iQIYI would need to increase its monthly subscription price by 70% solely to breakeven on P&amp;L content costs. Fourth, the similar user ratings of iQIYI and its competitors suggest little discernible difference in functionality. Content is the key differentiator for attracting subscribers.</li><li>iQIYI will likely require external funding for the foreseeable future. Netflix has reported a negative free cash flow (FCF) since 2012 due to increasing content costs. Considering iQIYI’s continued operating losses and rising content costs, its FCF profile will likely be worse than Netflix.</li></ol>We will provide an updated view when the SEC F-1 filing is published.

iQIYI is a leading Chinese online video platform, backed by Baidu Inc (ADR) (BIDU US), an 80.5% shareholder. In its 4Q17 results on 13 February, Baidu detailed that iQIYI submitted a draft registration statement to the SEC for an IPO. According to press reports, iQIYI is seeking to raise $1 billion by the end of 1Q or early 2Q18.Overall, we are cautious on the upcoming iQIYI IPO. The Chinese online video platform market is structurally unprofitable due to fierce competition, low subscription prices and rising content costs. In China, the main online video platforms are moving away from a YouTube type advertising revenue model to a Netflix Inc (NFLX US) type subscription revenue model.Deep-pocketed parent companies such as Tencent Holdings Ltd (700 HK) and Alibaba Group Holding Ltd (BABA US) can justify the ongoing funding of their online video subsidiaries as part of a broader strategy of generating shareholder value through a cross-media IP strategy. However, for independently run companies such as iQIYI post-IPO, it will be challenging to generate shareholder value due to:The careful management of content costs is crucial to delivering sustainable and profitable growth. We estimate that iQIYI’s content cost as a percentage of subscriber revenue averaged 260% over the last three years. In other words, iQIYI is spending $2.60 on content for every dollar in subscriber revenue. In contrast, Netflix International spends $0.70 on content for every dollar in subscriber revenue.iQIYI is stuck in a vicious cycle of content costs exceeding subscriber revenue due to four factors. First, despite stiff competition, iQIYI seems to be underspending on content. We estimate that iQIYI’s content costs accounted for 47% of operating expenses in 2017 vs 71% for Netflix. Second, iQIYI along with competitors, have low user retention rates of around 33%. Third, the subscription prices in China are relatively low. We estimate that iQIYI would need to increase its monthly subscription price by 70% solely to breakeven on P&amp;L content costs. Fourth, the similar user ratings of iQIYI and its competitors suggest little discernible difference in functionality. Content is the key differentiator for attracting subscribers.iQIYI will likely require external funding for the foreseeable future. Netflix has reported a negative free cash flow (FCF) since 2012 due to increasing content costs. Considering iQIYI’s continued operating losses and rising content costs, its FCF profile will likely be worse than Netflix.We will provide an updated view when the SEC F-1 filing is published. 

IQIYI IPO Preview: Likely to Remain a Not-For-Profit

China

iQIYI, Inc. offers video entertainment services. The Company provides movies, television dramas, variety shows, and other video contents. iQIYI offers services worldwide.

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iQIYI Inc (IQ US)

IQIYI IPO Update: Still Likely to Remain a Not-For-Profit

iQIYI filed for a Nasdaq IPO to raise $1.5 billion on 27 February. It is a leading Chinese online video platform backed by Baidu Inc (ADR) (BIDU...

Arun George

IQIYI IPO Preview: Likely to Remain a Not-For-Profit

iQIYI is a leading Chinese online video platform, backed by Baidu Inc (ADR) (BIDU US), an 80.5% shareholder. In its 4Q17 results on 13 February,...

Arun George

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