iQiyi (NASDAQ:) is China’s leading streaming service. It’s attracting investors because it is delivering viewers. In fact, over the next two years some analysts project iQiyi’s user growth will climb 6.7% to 738 million. Average revenue per user is also expected to climb 8.3% to $17.60 per user.
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This number raises the question of . However, in the short term, more users should provide a nice tailwind for IQ stock. But I’m not so sure that iQiyi has the right business model for long-term growth.
iQiyi is like Netflix if Netflix Were Owned by Alphabet
The most important caveat when discussing iQiyi is that it is a subsidiary of Baidu (NASDAQ:), China’s leading search engine. iQiyi is seen as a key source of revenue for Baidu (which still owns 58% of IQ) as it attempts to halt a steep skid in its own stock price. So whenever you talk about iQiyi making over 70% from advertising revenue you have to remember that it’s Baidu that’s generating that revenue.
iQiyi on the other hand makes its revenue through sales of its subscription services and content marketing. Proponents of IQ stock will say that iQiyi currently has about one-half of the Chinese market. But even with only half the market, it still has more users than Netflix (NASDAQ:). Plus, by keeping subscription costs very low (approximately $3 in U.S. terms), it will have no problem capturing more of the Chinese market.
Do Chinese Consumers Really Love Ads?
There are U.S. companies (e.g. Alphabet (NASDAQ:, NASDAQ:GOOGL) and Facebook (NASDAQ:)) that rely on advertising revenue. But that business model is starting to come under attack. Consumers are more aware than ever that the advertising content they receive comes at the expense of their personal privacy. This conflict is being played out in the stocks as investors wrestle with what companies such as Facebook look like with falling advertising revenue.
I have to believe that iQiyi will be facing the same issues. The theory is that China is the leader in e-commerce so it stands to reason that Chinese consumers will be drawn to advertising like a moth to a flame. However, viewing habits in China don’t seem to support this theory. A by digital brand researcher L2 cited that the streaming habits of Chinese consumers revolve around live-streaming events that resemble the QVC network. One of the reasons why Chinese consumers are attracted to this format is because there is no hard sell. It’s part infomercial, part reality TV and keeps them more engaged.
This isn’t to say that iQiyi doesn’t have a large user base, but it does suggest that Chinese consumers are not going to pay more for content that includes advertising. They go elsewhere for that.
iQiyi Can’t Afford to Be Netflix
Netflix subscribers pay between $10-$16 for a subscription. With that subscription, they get exactly what they want – – the potential for hours upon hours of uninterrupted viewing. But even though Netflix, which started out as a home delivery service for DVDs, has evolved its business model to incorporate original content, it is still facing two emerging threats. First, original content costs a lot to produce. Second, the two most popular shows on Netflix, “The Office” and “Friends,” will no longer be available on the service after 2020.
IQ by contrast can afford to keep the price of their subscription low because of Baidu. However, perhaps recognizing the need to give Chinese consumers more variety, iQiyi is still taking on the expense of producing original content. This creates a math problem.
Netflix is struggling to remain profitable while charging between three and five times what iQiyi charges their customers. So where is the profit going to come from for iQiyi? Advertising will only take it so far. Eventually, no many how many viewers they deliver, advertisers will expect a return on their investment. But Chinese viewers are already skeptical of traditional advertising, so I’m not sure how that model works long term.
The Bottom Line for IQ Stock
It wouldn’t surprise me if IQ stock rises in the short term as the company expands its user base. However, as much as IQ wants to position itself as the Chinese version of Netflix, investors will need to see a profit and consumers may want to see commercial-free viewing.
That presents iQiyi with a trap that I just can’t square with long-term success.
As of this writing, Chris Markoch did not hold any of the aforementioned securities.
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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.