Better Buy: iQIYI vs. Netflix

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="The streaming revolution is taking over. In the U.S., traditional media companies are merging and scrambling to catch up to Netflix, which invented the streaming concept and has a multiyear lead on rivals.” data-reactid=”11″>The streaming revolution is taking over. In the U.S., traditional media companies are merging and scrambling to catch up to Netflix, which invented the streaming concept and has a multiyear lead on rivals.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Meanwhile in China, each of the country's leading tech companies picked up on the streaming concept early. The early leader was iQIYI, which was partially spun out of Chinese search engine giant Baidu (NASDAQ: BIDU) last year. However, in 2017, Tencent (NASDAQOTH: TCEHY) Video passed iQIYI in terms of subscribers, though both are growing by leaps and bounds and are currently neck-and-neck for Chinese streaming supremacy.” data-reactid=”12″>Meanwhile in China, each of the country’s leading tech companies picked up on the streaming concept early. The early leader was iQIYI, which was partially spun out of Chinese search engine giant Baidu (NASDAQ: BIDU) last year. However, in 2017, Tencent (NASDAQOTH: TCEHY) Video passed iQIYI in terms of subscribers, though both are growing by leaps and bounds and are currently neck-and-neck for Chinese streaming supremacy.

So, which streaming leader – Netflix or iQIYI — looks like the best bet today?

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Image source: Getty Images.

Subscriber and revenue growth

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Since both Netflix and iQIYI are growth companies, analysts often first look to their top lines. For Netflix, that means subscriber and revenue growth. Netflix has also been able to raise its prices in recent years, adding revenue above and beyond its mere subscription figures.” data-reactid=”27″>Since both Netflix and iQIYI are growth companies, analysts often first look to their top lines. For Netflix, that means subscriber and revenue growth. Netflix has also been able to raise its prices in recent years, adding revenue above and beyond its mere subscription figures.

iQIYI, on the other hand, gets revenue from both premium subscribers and advertising from its free video offering. In that sense, iQIYI may be more like a mix of YouTube and Netflix, rather than a direct parallel.

Source: Netflix and iQIYI annual reports. Table by author.

Looking purely at the subscriber growth rates, it’s clear that iQIYI is the winner here; however, there is more to the story.

Netflix has a mix of both domestic and international addressable markets. Netflix’s domestic subscriber growth slowed in 2018 to just 11%, as it gets closer to U.S. saturation. On the other hand, Netflix’s international segment surged 40%, matching the growth rate from a year earlier. Netflix had a subscriber base roughly twice the size of iQIYI’s at the start of last year, so these lower growth numbers are still wildly impressive. In addition, the international segment’s gains should sustain Netflix’s overall growth at pretty high levels for the foreseeable future.

On the other hand, iQIYI also has some impressive underlying dynamics. Though its subscriber growth actually exceeded revenue growth, it wasn’t due to price cuts. Membership revenue actually grew 72.3%, in line with subscriber growth.

The lower overall growth rate came from a lower advertising growth rate of just 21.2%. Advertising had been a larger part of iQIYI’s base until last year, when subscription revenue surpassed advertising as the company’s largest segment. Like Netflix, it appears iQIYI can sustain a high growth rate for the next few years at least.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Winner: iQIYI” data-reactid=”37″>Winner: iQIYI

Profitability (or lack thereof)

Of course, there’s more to a company’s value than its revenue growth. At some point, investors need to have a line of sight to profits.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="With media companies, the costs of production can be a bit strange from an accounting perspective. Media companies usually capitalize their current content spend, and then amortize the portion of that "investment" that lines up with subscription revenue over the life of the show or movie. It's an imperfect system, but the total actual spend is still fully reflected on the cash flow statement.” data-reactid=”40″>With media companies, the costs of production can be a bit strange from an accounting perspective. Media companies usually capitalize their current content spend, and then amortize the portion of that “investment” that lines up with subscription revenue over the life of the show or movie. It’s an imperfect system, but the total actual spend is still fully reflected on the cash flow statement.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="For instance, Netflix, on a GAAP basis, is actually profitable. The company posted an operating profit of about $1.6 billion and an operating margin of just over 10% in 2018. That is&nbsp; infinitely better than iQIYI, which not only posted a negative operating margin of (33%) but a negative gross margin of (8.6%) in 2018 as well. That’s right — The company paid more for content, even on a capitalized basis, than it took in revenue.” data-reactid=”41″>For instance, Netflix, on a GAAP basis, is actually profitable. The company posted an operating profit of about $1.6 billion and an operating margin of just over 10% in 2018. That is  infinitely better than iQIYI, which not only posted a negative operating margin of (33%) but a negative gross margin of (8.6%) in 2018 as well. That’s right — The company paid more for content, even on a capitalized basis, than it took in revenue.

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