iQIYI: Long-Term Story For The Company Stays Intact

Overview

Not much has changed in my thinking about iQIYI (NASDAQ:IQ). The online video industry in China has a secular trend in its favor because of rising disposable income and improved consumption habits, as well as a diversified business model that includes membership fees, online advertising, content distribution, and other revenue streams made possible by fully realizing the potential of its IP content. IQ's original content, which includes a wide range of variety shows and drama series, is its main competitive advantage. This is due to the company's innovative culture, which centers on the merging of technology and creativity, and the efficient work of its management team in recognizing shifts in consumer taste.

The decline in IQ's share price following the result, in my opinion, was caused by investors cutting their holdings following a sharp uptick. Because most of the performance drivers are structural rather than temporary, I believe IQ's recent strong financial performance can be maintained. The macroeconomic recovery, the rising popularity of long-form video in China, and the increasing time spent consuming this type of content are all factors that have contributed to the growth of this market. Overall, I recommend continuing staying long in IQ as I think there will be more share price re-rating in the future thanks to financials beating and consensus upgrades.

Earnings review

As a result of a 15% increase in membership revenue and a 15% increase in total subscribers to a record-breaking 112 million in 4Q22, IQ posted strong revenue growth. Operating margin increased 20 percentage points from the previous year to reach 13%, complementing the firm's strong revenue growth. The strategy of producing original content is what I believe has contributed to IQ's success, with original programming now making up more than half of the network's drama broadcasts (up from 20% in 2018). The direct impact is that with fewer drama purchases and cheaper prices for each drama, IQ also sees a reduction in content costs. My expectation is that in the next two to three years, IQ's subscriber base will expand thanks to the network's original content strategy. Similar to Netflix (NFLX), high-quality, exclusive, and widely-appreciated content has the potential to attract new paying customers and keep existing ones.

Strategy forward

As far as subscription fees are concerned, I see original dramas as a major revenue driver in the near future. As we've seen, so far, this strategy seems to be paying off, and there are 2 key reasons why I think IQ's original content is doing so well. First, I believe IQ's production teams are among the best in the business. Its in-house studios are staffed by talented individuals who bring a wide range of creative perspectives to the table, and support staff covers a wide range of operational areas to ensure the smooth running of operations from ideation to distribution to promotion. The second advantage is that IQ's highly developed and refined mechanisms allow for effective content selection, cost optimization, and managing content cadence that is optimal. As such, management is confident that both ARM and subscriber growth will contribute to the future expansion of membership service revenue. Investments in both content and promotion should lead to expanding subscriber bases. But management has said that in order to support ARM expansion, there will be fewer discounts and higher membership fees. Given that the initial content strategy can be interpreted as a cost to acquire new customers, I agree that a pullback on discount makes sense.

Margin

In my opinion, IQ has a great deal of potential for enhancing its long-term profitability through measures such as controlling content costs, increasing prices, and gaining operational leverage. In fact, management has moved the goalposts, placing a greater emphasis on margin expansion with quality growth through investments in the core business and in projects with a higher ROI.

Content cadence

From what I was able to glean from a cursory Internet search, IQ aired a number of original series and movies in the 1Q23. Without naming names, I believe IQ is proving once again its superior production value by consistently releasing well-received works. For the foreseeable future, I have no doubt that IQ will release new episodes that are well received by subscribers.

Conclusion

I still believe IQ is well-positioned for continued success in the Chinese online video industry. Furthermore, the company's innovative culture and efficient management team enable it to recognize shifts in consumer taste and produce original content that is highly valued by subscribers. I am still optimistic about IQ's future financial performance and believe that the company's strong revenue growth, expanding subscriber base, and increasing operational leverage will drive profitability in the long term. Finally, the company's continued focus on content cadence and margin expansion through quality growth investments is a positive sign for investors looking for sustainable returns. Reiterate buy rating.