Company Reports

We maintain our fair value estimate for Iqiyi at $5.20 after it reported first-quarter revenue of CNY 7.9 billion, which was 2% better than our estimate, driven by a 28% increase in content distribution business but offset by a 13% decline in membership revenue. We estimate that membership levels declined by 23% year on year to 99 million users. While we anticipated a falloff in memberships and revenue due to a high base effect last year from Iqiyi’s hit drama, the decline was worse than expected. Further compounding the issue is management’s decision to no longer disclose the number of memberships, which underscores our concern over its ability to retain a consistent level of users on its platform. However, operating margin (excluding stock-based expense) increased by 140 basis points to a record-high 13.7%, likely driven by content distribution revenue growth, which also reached a record-high $928 million.

We are encouraged that Iqiyi has been successful at turning around its business to generate high-single-digit operating margins, which are a significant improvement from a 30% operating loss margin since its IPO in 2018. We expect Iqiyi to maintain profitability in the near term because of expectations of lower content costs that are 50%-60% of sales, rather than the 70%-80% level prior to 2022. However, we forecast that subscription prices and memberships will grow at only low-single-digit levels, given our view that Iqiyi will have challenges in retaining customers on a consistent basis and is vulnerable to switching costs and churn.

We retain our fair value estimate of $5.20 per share for Iqiyi after fourth-quarter revenue of CNY 7.71 billion was in line with our estimate of CNY 7.68 billion. The firm generated GAAP operating margins of 7%-10% consistently for five consecutive quarters, leading us to be more confident about the company's outlook and long-term positive cash flow. Margin expansion was cost-driven as revenue grew only 1% year on year, but Iqiyi continues to be prudent in content spending. It expects further margin improvement next year, but this would be driven by the top line as it plans to increase its monthly subscription fees. Iqiyi guided to $5 billion in non-GAAP operating income for 2024, representing a 37% increase year on year and margin expansion of 300 basis points. It did not indicate the 2024 fee increase, but we estimate an increase to an average fee of CNY 18 per month, which suggests a 20% year-on-year increase. This is consistent with Iqiyi’s long-term strategy, as it remains confident that it can increase monthly subscription fees to CNY 20-CNY 25 while reaching 150-200 million users on a long-term basis.

We maintain our fair value estimate of $5.20 for no-moat Iqiyi after third-quarter results were mixed as operating margins (stock-based expenses included) increased 150 basis points to 9.3% and revenue increased 7% year on year, driven by higher monthly average revenue per membership, but users continued to gradually decline on the video-on-demand platform from its first-quarter 2023 peak. Overall, revenue was driven by membership revenue of 9% year on year as ARM increased by 12% during the same time to CNY 15.54 from CNY 13.90. Ad revenue growth of 34% year on year also contributed to overall growth as Iqiyi continues to add incremental performance-based ads to its platform. Management did not provide guidance for the next quarter, but expects ARM to grow further. We expect Iqiyi to remain profitable as it develops further in-house content that is cheaper to make, than acquiring third-party content. However, we believe that until Iqiyi can consistently show an increase in users, the company’s valuation ceiling is limited.

We are initiating Iqiyi with a fair value estimate of $5.20. The modest upside reflects our view that customer growth has been a historical challenge despite recent encouraging signs of profitability. Efforts to bolster its content library, both in quantity and quality, have shown briefs signs of success, but have not translated to longer-term growth. Membership growth has remained stagnant, fluctuating between 100 million and 112 million from second-quarter 2019 to end-2022, despite incurring heavy losses from elevated spending on content in the attempt to provide a vast content library on its platform. However, this has not resulted in customer growth, and Iqiyi recently shifted to providing less but higher-quality content for its platform.

We are encouraged that Iqiyi has been successful at turning around its business to generate high-single-digit operating margins, which are a significant improvement from a 30% operating loss margin since its IPO in 2018. We expect Iqiyi to maintain profitability in the near term because of expectations of lower content costs that are 50%-60% of sales, rather than the 70%-80% level prior to 2022. However, we forecast that subscription prices and memberships will grow at only low-single-digit levels, given our view that Iqiyi will have challenges in retaining customers on a consistent basis and is vulnerable to switching costs and churn.