Profitability Remains a Huge Issue for IQ Stock

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At one point in time, there was robust enthusiasm surrounding Chinese internet streaming giant iQiyi (NASDAQ: IQ ). Given its roots in the streaming market and huge revenue growth rates, many market observers were calling iQiyi the " Netflix (NASDAQ: NFLX ) of China". On that positive comparison, IQ stock soared from an $18 IPO price in March, to nearly $50 by June.

Then, reality hit.

Namely, the same things that stung Netflix stock a few years back, hit iQiyi stock a few months back. Despite huge and sustained revenue growth, margins are a huge question mark, and those questions are only getting bigger with ballooning content costs.

Netflix was able to break through the profitability wall because of subscriber base scale and subscription price hikes. Neither of those look like a sure thing for iQiyi at this point in time. As such, IQ stock has sunk 70% over the past six months.

Shares project to remain weaker for longer. Until investors have reason to be optimistic about profitability, they won't bid up IQ stock. That won't happen any time soon. As such, IQ stock won't stage any big turnaround rally in the foreseeable future.

There's A Lot To Like About iQiyi

Despite the recent plunge in IQ stock, there's still a lot to like about this stock from a long term investment perspective.

iQiyi is, for all intents and purposes, the Netflix of China. The company has over 80 million subscribers who stream movies and TV shows through their platform. The only other streaming video platforms that compare are Tencent Video, which sports just over 60 million subscribers, and Youku.

Regardless of the exact figure, iQiyi is part of the Big 3 in China's streaming market. This market projects to be huge. There are 4.2 billion internet users in the world. Nearly 800 million of them are from China alone. From America's 320 million internet users, there are 125 million streaming-video-on-demand subscriptions, implying about 40% penetration. Applying that same rate to China, China's streaming market could measure in excess of 300 million subscriptions in a few years. That figure stands at just over 200 million today.

Meanwhile, iQiyi has 80 million subscribers. That number grew by nearly 90% year-over-year last quarter. Given China's huge internet population and low SVOD penetration rate, it looks likely that iQiyi will sustain this huge growth for a lot longer. Indeed, the last time Netflix saw subscriber growth north of 50% was back in late 2010. Eight years later, Netflix is still growing subscribers at a 25% rate. Thus, small penetration with a big growth rate implies a long runway ahead for subscriber growth at iQiyi.

If you assume the Netflix trajectory for iQiyi of big subscriber growth, price hikes, and eventual profitability, then there's plenty to like about IQ stock long term. Indeed, this stock could end up being a multi-bagger, much like Netflix.

"Next Netflix" Potential Is Clouded By Profitability Risks

The long-term bull thesis in IQ stock, while compelling, lacks clarity at the current moment due to the lack of a tangible and visible pathway to profitability.

Netflix struggled with this early on, too. Content costs aren't small. But, you need more content to get more subscribers. Thus, content costs pile up before subscriber revenue piles up, so streaming giants tend to run big losses for a long time before they reach profitability. Netflix burst through that wall because it got enough subscriber revenue to offset content costs. Interestingly enough, Netflix's margins didn't start to improve meaningfully and benefit from opex leverage until revenues hit about $8 billion in 2017.

iQiyi's revenues over the past twelve months measure under $4 billion. Thus, iQiyi has a long ways to go before it can theoretically leverage operating expenses in a way that will drive huge profitability gains.

iQiyi could get there. But, because China SVOD subscription prices are so low (the standard price for streaming service subscriptions globally is around $10 per month, whereas it is just $3 per month in China), iQiyi will need a ton of subscriber growth to get to that $8 billion mark. That's possible. But, also risky.

As such, investors aren't willing to put a bid a under IQ stock yet because profitability remains a question mark. So long as this remains a question mark, IQ stock will remain weak.

Bottom Line on IQ Stock

The long-term growth potential of IQ stock as a multi-bagger in the rapidly growing China streaming economy is compelling. But, the market won't focus on this potential until the company adds clarity to its profit situation. Until that happens, IQ stock will remain weaker for longer.

As of this writing, Luke Lango was long NFLX.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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