The Two Best Reasons IQ Stock Looks Like the Best Bet for China Bulls

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Buying iQiyi (NASDAQ: IQ ) or any Chinese stock right now requires nerves of steel. Chinese stocks have been hammered of late, and iQiyi stock hasn't been spared. IQ stock has dropped 56% from June highs, and at $20 isn't far from its April IPO price of $18.

There are reasons to stay on the sidelines. The chart is ugly. Competition is coming from all corners, most notably Tencent Holdings (OTCMKTS: TCEHY ). The U.S.-China trade war isn't over, and the Chinese yuan could be further devalued. Trying to time the bottom here is a dicey proposition, as many investors in IQ stock already have learned.

But I've long thought there was fundamental value in iQiyi stock despite high headline valuation multiples. And while I've raised caution for the reasons cited above, near $20 IQ is getting intriguing to say the least.

iQiyi isn't quite the " Netflix (NASDAQ: NFLX ) of China" some bulls have argued, but it has impressive growth potential. The sell-off here looks overdone, and when Chinese stocks eventually rally, it very well may be IQ stock that leads the way, for two key reasons.

IQ Stock Isn't Like the Other China Plays

An investor can't simply argue that iQiyi is a purely domestic operator and therefore has zero exposure to trade war and tariff concerns. Few Chinese companies have substantial export businesses: Alibaba (NYSE: BABA ) and (NASDAQ: JD ) are expanding geographically, but still generate the lion's share of revenue and profits in-country.

The issue for those stocks, as well as for IQ stock, is not that they won't be able to sell into the United States. Rather, the fear is that the trade war itself is going to slow down, if not collapse, the Chinese economy.

Partially in response, China has devalued its currency already, and could continue to do so. That in turn lowers the value of in-country earnings and the value of iQiyi profits to a U.S. investor.

That said, it does seem like IQ should be less exposed to the U.S.-China battle than other Chinese plays. A slowing economy hits Alibaba and directly but iQiyi indirectly.

Fewer jobs and less economic growth means less money for the discretionary purchase of a video streaming subscription, and likely less spend from advertisers. But that's not quite the same risk as having customers and suppliers go bankrupt.

There's also the secular tailwind here. Video streaming is going to grow even if the economy weakens, and in China, it's not exactly a high-dollar purchase. Chinese consumers are more price-sensitive than their U.S. counterparts, but why that is remains unclear. Is there a cultural reluctance to pay for content? Or do Chinese consumers simply have less money?

Whatever the explanation, iQ's reach should continue to grow. Macro issues perhaps slow that growth, but with a 50%+ decline, some level of slowing growth already looks priced in.

If iQiyi Stock Wins, It Wins Big

Make no mistake: any investor in iQiyi can lose 100% of her capital. iQiyi continues to burn cash and will do so for a while. And there's an obvious scenario in which larger Alibaba (through its Youku Tudou) and Tencent simply outmuscle and outspend iQiyi right out of the market.

It's an unlikely scenario, to be sure, given that iQiyi finished Q3 with over 80 million subscribers. But success, however that might be measured, is not guaranteed.

That said, even at a $14 billion valuation, success isn't priced in, either. The average Netflix subscriber is valued by the market right now, even with NFLX stock down 37%, at about $875. The average iQiyi subscriber is worth about $160.

Investors can see that divergence in a number of ways. iQiyi subscribers probably should be worth less. Tencent is a more fearsome competitor than Hulu or (NASDAQ: AMZN ), and one with larger market share. Netflix's addressable market might be larger (that probably depends on how the Indian market shakes out). Netflix subscribers pay much more.

Still, iQiyi is earlier in its growth. It has 80 million subscribers in a country of 1.4 billion. Netflix has 58 million subscribers in the U.S., with a population just over 300 billion. And iQiyi's advertising revenues are substantial; whereas those of Netflix, at least at the moment, are basically zero.

By no means should IQ be valued equivalently to NFLX on a per-subscriber basis. But what about one-third of NFLX? Or even one half? At 1/3, IQ stock rallies to about $35. At one-half, it nearly triples to around $60. Even that latter figure only suggests a price-to-revenue multiple around 9x - which not that long ago wouldn't have seen outlandish for a Chinese growth play.

Be Careful out There

To be clear, I'm not arguing that IQ stock is going to $60, particularly any time soon. But there is a simple scenario where iQiyi stock doubles or better: sentiment toward China improves and the company continues to take market share.

When that sentiment changes is the sticking point here, and even aggressive investors might want to use some caution.

Selling puts is one strategy to limit risk: the June 2019 20 put can be sold for about 20% returns, with the downside being owning IQ stock under $17. Investors might also want to keep a close eye on the chart, which doesn't seem to show much in the way of near-term optimism.

But if and when an investor wants to dip a toe into Chinese stocks, IQ looks like it could be the best choice. It should have less direct impact from trade war concerns than its peers. Valuation, given growth, has come in to a reasonable level. Competition is the biggest risk, but even in a supposedly disappointing Q3 report iQiyi showed solid subscriber and overall revenue growth.

If sentiment toward China changes, IQ stock should rebound. It's the "if"and the "when" of that change that look like the most difficult, and most dangerous, part of the story right now.

As of this writing, Vince Martin has no positions in any securities mentioned.

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The post The Two Best Reasons IQ Stock Looks Like the Best Bet for China Bulls appeared first on InvestorPlace .

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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