Disclaimer: These notes are shared for informational and educational purposes only. THIS IS NOT INVESTMENT ADVICE.

Key takeaways:

  • Almost at 100M subscribers (grew 58% yoy in 1Q)
  • iQiyi’s advert business slowing (cyclical or secular?)
  • Some content releases are delayed (impacts advert business)
  • There were some disclosure changes in IQ’s 20-F (Grrr!)

Content Delays

English: Over the Sea I Come to See You

A show, called 带着爸爸去留学, had its broadcast date delayed. There was some speculation online that the delay was due to the US-China trade dispute. The show is about a dad and his kid going to the US to study abroad with about 90% of the show filmed in the US. Along with many others, iQiyi was supposed to broadcast in May 2019, but its release date was pushed to June 13th.

Revenues & Weak Guidance

iQiyi offered (historically) very modest guidance for 2q19. The mid-point of the range is RMB 7.1B (yellow dot in chart above) is only 15% YoY and 2% sequentially. Compared to the prior two second quarters that is a significantly low estimate. The reason given on the earnings call is content delays and continued deceleration in online advertising. Note this guidance was given halfway through 2Q.

I do not think they are aiming for an easy beat. First off, their prior estimates were fairly close. Second, their revenues have flattened in last three quarters. And finally, content delays and declining online advertising revenues could make 2Q tough for iQiyi. 

The reasons given for the declining advertising revenues make sense and are all cyclical in my opinion. The reasons given are: content delays, in-feed clean up, soft macro environment, certain verticals cutting ad budgets because of weak macro or regulations (online gaming), and higher ad inventories overall for the industry.

I believe higher ad inventories (supply) will prove to be cyclical when ad demand growth recovers. The main reason is I have a hard time imagining scenarios where demand for ad inventory does not recover, besides a long drawn-out recession.

With the content delays, one of the fears is that the delays will last a long time, or worse, be permanent.

Wang Xiaodong (CFO) responded to a question on the earnings call, saying iQiyi never had a case where content was delayed then never released. “We don’t expect that to happen.”

For this very reason, I wanted to see if 带着爸爸去留学 was released on schedule (June 13th). It was. As this free show is specifically about the US and 90% of it is filmed there, it is important sign that it got released during a time of tense US-China relations. 

(I noted one of the ads in the show was a reminder to stay safe when in the United States and to call the Chinese consulate/embassy if you experience any problems. I guess that was part of the bargain to get it released.)

As of today (17-Jun-2019), I believe fears of permanent content delays are over blown.

Segments: Gaining Subscribers, Slowing Online Advertising

Revenue is getting a boost from Member services which are up 64% YoY (8% seq), with subscribers up 58% YoY (see below). Yu Gong (CEO) attributes the rise to their quality premium content and targeted marketing campaigns. 

But… Online Advertising has been suffering since 2q18, which was the first full quarter after online games approvals were halted in March 2018. The pain in online advertising is being felt by many companies, as Elliot and I have discussed on China Tech Investor podcast.

Some may be quick to claim the growth divergence between Member Services and Online Advertising is representative of a change in iQiyi’s strategy. It is not.

Yu Gong (CEO) speaks frequently about the need for more monetization channels for online content. It is clear to me he really believes in this. He wants iQiyi to offer free content, as well as high quality original content.

Disclosure Changes

Readers will know from my Pinduoduo post that I find disclosure changes are usually a red flag (cause for concern). I usually trim positions if I’m long when I see this, or even reverse the position entirely.

What changed?

  • Changed quarterly average active users to annual average active users without providing historical comps.
  • Changed user time spent disclosure without providing historical comps.
These are not apples-to-apples…

My guess is (1) the Yanxi Palace drama released in 3Q18 was such a hit that they wanted to spread those active user figures out and (2) 4Q18 active user figures were either flat or, most likely, below 3Q18 levels.

Because this new number does not compare to prior active user disclosure, they also dropped the below table from the recent Form 20-F:

Source: Form F-1 filings

Changes like these are annoying for analysts and investors, especially when they don’t provide comparative figures.

Recently, I was asked if all disclosure changes are red flags. Short answer: no… but I’m not happy with the changes iQiyi made here.

Earnings Call Highlights

YG (CEO): “Looking ahead, we maintain a cautious outlook on advertising due to the soft macroeconomic environment in China and slower-than-expected recovery of our in-feed advertising.”

YG: “In particular, our original drama series, The Thunder, has not only been well received by all users but also highly acknowledged by government officials. And it become the first original series aired during prime time on drama channel of CCTV. Furthermore, it is expected to hit international market through RED BY HBO, which acquired the Southeast Asia licensing rights of the show.”

Note: The Thunder is 破冰行动 in Chinese and it looks particularly good.

Q&A on Advertising

Question – Content costs down sequentially almost 20% (actual -18%), trend or one-off? How do you see content costs in coming quarters?

YG: [interpreted] Major reason this quarter is delay of some of our content. Delay due to policy changes and regulatory censorship. Also related to process of content production. On regulation, I think level this year will be relatively stable compared to last year, but there are some anniversaries of political events in Q2/Q3 so will be stricter than before.

Question – Strong total subscriber growth. How do you see competitive landscape going forward? 

YG: Yes, outperformed peers in subscriber growth. Thinks attributable to very strong original content offered in the first quarter. But there’s also something related to the scheduling of the content, how to balance mix of content to be aired and bench-marking to what other companies are offering.

WXD (CFO): “But however, as I just said, we’ll remain very cautious on the forecast of the entire advertising business in the next few quarters or even next 2 years because of the relatively weak macro environment.”

Question – Can you dissect the advertising business performance, what’s driving bearish view on advertising business in 2Q?

YG: Three revenue drivers: one Subscriptions, two is advertising. Two factors impacting advertising revenue. (1) is the content delay as mentioned. (2) is, as everybody knows, the softer macro environment. As a result, certain verticals have lowered their ad budget. In advertising iQiyi has in-feed advertising, we did some cleanup later half of last year, that’s another drag. “In addition, because of the in-feed ad inventory side, the overall inventory is coming up from all of the industry, but on the other hand demand, is not so upbeat. As a result, the CPM is returning trend to a normal level.”

Third revenue driver is other business, which “contain a lot of IP derivative revenues including game and other IP-related revenues, which can be potentially a long-term driver for us.

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