Spencer Platt
Summary
Following my coverage of iQIYI (NASDAQ:IQ), I recommended a buy rating due to my expectation that IQ will continue to report sustainable, profitable growth. This post is to provide an update on my thoughts on the business and stock. I reiterate my buy rating for IQ as the business continues to showcase sustainable profitable growth, especially with content cost moderating as a percentage of revenue while consistently putting out blockbuster hits. The improved outlook for advertising also reinforces my positive outlook that margins should continue to increase.
Investment thesis
The 17% increase to RMB 7.8 billion in revenue met market forecasts. Membership services brought in RMB 4.9 billion in revenue, up 15% year-over-year. It’s important to keep in mind that the drop from 128.9 million in 1Q23 to 111.2 million in the daily average number of subscribers is likely due to subscribers hopping on and off as they finish a particular drama or movie. Earnings from online advertising also increased, reaching RMB 1.5 billion, a 25% increase from the previous year. A key statistic to highlight is the operating income growth, which skyrocketed to RMB 786.4 million, more than doubling the 2Q22 figure of RMB 344 million.
As IQ continues to shift its focus from optimizing subscriber growth to growing subscription revenue, I remain optimistic about the future of subscription revenue. Going forward, I anticipate stable ARM improvements as IQ releases more high-quality content and decreases the frequency of discounts. Regarding the former, I believe it is well supported by a strong pipeline schedule. The Story of Kunning Palace, The Demon Hunter’s Romance, My Journey to You, and A Journey to Love are, according to my research, the next “hit” films and dramas to be released. Of course, everyone has their own tastes, so it all comes down to personal opinion. But my expectation is that Chinese drama will continue to gain attention in the coming years, which is a trend that K-drama is undergoing currently. Given that the upcoming content has a similar style to recent historical Chinese drama success, I think their release will be the main factor in growing the number of subscribers in 2H23. My expectation is that IQ’s subscription revenue visibility will improve further in the long run as the proportion of annual subscribers increases. This would be contingent on IQ continuing to release blockbuster hits, which I think they can.
Let me emphasize again how important it is to prioritize long-term, profitable growth. So, it was heartening to learn that despite increases in both quantity and quality, the price of content did not rocket. Consistent with my prediction that IQ’s margins will grow steadily as a result of its growing quality subset and decreasing production costs, IQ has remained committed to registering healthy content cost. To put this in perspective, in 2Q23, content cost rose by only 7% to RMB4.1 billion, resulting in a drop from 58.6% of revenue in 2Q22 to 53.1% in 2Q23 of revenue as a result of positive leverage.
Margins should also further improvement as the high margin business – Advertising – come back online. Brand advertisements, in particular, have been on the upswing, according to management, thanks to IQ’s release of successful content hits (this also lend credence to my point that IQ released content are hitting the right spot in terms of consumer preference). Moreover, growth in performance advertising is outpacing that of brand advertising, and management anticipates a healthy recovery in 2H23 as a result of rising demand in the online retail, media, and travel sectors. I anticipate more subscribers joining the platform as IQ continues to release blockbuster hits, which will increase the value that IQ can provide to advertisers and, in turn, increase advertising revenue.
Conclusion
I reaffirm my buy recommendation, as IQ demonstrates a clear trajectory of sustainable, profitable growth. The recent financial results, including increased revenue, membership services growth, and improved operating income, underscore the effectiveness of IQ’s strategic shifts. As the company focuses on optimizing subscription revenue, bolstered by an array of upcoming high-quality content releases, I anticipate a substantial uptick in subscriber numbers. The controlled content cost, steady margins, and resurgence of high-margin advertising further solidify the positive outlook.
