iQiyi 1Q19 Earnings Notes

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.

Thanks for reading. If you want to be notified of new posts, please subscribe. I welcome your thoughts and comments. Continue the conversation in the comments, on Twitter @jameshullx or on LinkedIn.

Assets: Atoms versus Electrons

In this post I focus on the assets of a business, stuff that is owned by the business and is fundamental to the business model. Human capital is fundamental as well, but I will leave that for another day.

Note: the impetus of this post was a conversation with Elliott and Michael on China Tech Investor podcast (23): Is Luckin Coffee a real business? I believe Luckin Coffee is using scaling techniques that work for electron businesses but are not suited for atom businesses.

A post on Luckin Coffee where I will share my analysis on their traffic is in the works, you can follow this blog to receive posts by email. — And on to the post.

There is a difference between atom businesses (primarily focused on physical) and electron businesses (primarily focused on digital). Hat tip to Josh Wolfe for this concept.

Electron businesses are primarily media and software (in some cases intellectual property). They are supported by highly efficient infrastructure: fiber optic and copper data transfer, electricity generation and distribution, and electronic devices. Media and software is codified and stored on physical devices (sometimes in electrons), and can be infinitely flawlessly replicated. Storage costs for media and software are near zero: a hard drive on a laptop. Operating cost for software is low and can be “on demand”. Media operating cost is more about keeping it organized and available. Media and software have production cost and distribution cost. After media is produced it is in storage awaiting distribution. Maintenance costs for media are near zero. For software there are maintenance costs, they can range from high to low depending on complexity of the software and the rate of change in the underlying physical layer.

Atom businesses are primarily composed of physical things: assets or —stuff. All assets degrade over time to the point they are useless. Proper care and maintenance can extend an asset’s life, but it’s not free. Physical businesses also require “space” in the form of land or a physical location, which have to be found and acquired and come with carrying costs (such as leases, taxes). Physical locations (land, stores) are not easily spun-up or spun-down, unless a contractual-layer in the middle makes it so (such as a business renting month-to-month from WeWork).

Contractual-layer businesses redefine the contractual relationship on either the supply-side or the demand-side, usually the supply-side. For example, Uber redefined the supply-side for hired drivers (taxis, private car services) by allowing anyone with a phone and a car to become a driver, in effect circumventing the hiring/vetting process or stringent cab-driver license requirements. This lowered the barrier for drivers on the supply side. On the demand side, Uber used infrastructure available (electronic devices and GPS) to replace location-based hailing (standing on the sidewalk) and phone-call hailing with an app on a device with GPS.

Thanks for reading. I welcome your thoughts and comments. Tell me how I’m wrong on Twitter @jameshullx or on LinkedIn.

Naval’s How to Get Rich (without getting lucky)

Reproduced in full below. This is easily one of the best modern pieces of advice, probably on par with Kiplinger’s  “If” and Ehrmann’s “Desiderata”, though not as poetic. Follow @naval on twitter. The original threaded tweet.

Seek wealth, not money or status. Wealth is having assets that earn while you sleep. Money is how we transfer time and wealth. Status is your place in the social hierarchy.
Understand that ethical wealth creation is possible. If you secretly despise wealth, it will elude you.
Ignore people playing status games. They gain status by attacking people playing wealth creation games.
You’re not going to get rich renting out your time. You must own equity – a piece of a business – to gain your financial freedom.
You will get rich by giving society what it wants but does not yet know how to get. At scale.
Pick an industry where you can play long term games with long term people.
The Internet has massively broadened the possible space of careers. Most people haven’t figured this out yet.
Play iterated games. All the returns in life, whether in wealth, relationships, or knowledge, come from compound interest.
Pick business partners with high intelligence, energy, and, above all, integrity.
Don’t partner with cynics and pessimists. Their beliefs are self-fulfilling.
Learn to sell. Learn to build. If you can do both, you will be unstoppable.
Arm yourself with specific knowledge, accountability, and leverage.
Specific knowledge is knowledge that you cannot be trained for. If society can train you, it can train someone else, and replace you.
Specific knowledge is found by pursuing your genuine curiosity and passion rather than whatever is hot right now.
Building specific knowledge will feel like play to you but will look like work to others.
When specific knowledge is taught, it’s through apprenticeships, not schools.
Specific knowledge is often highly technical or creative. It cannot be outsourced or automated.
Embrace accountability, and take business risks under your own name. Society will reward you with responsibility, equity, and leverage.
The most accountable people have singular, public, and risky brands: Oprah, Trump, Kanye, Elon.
“Give me a lever long enough, and a place to stand, and I will move the earth.” – Archimedes
Fortunes require leverage. Business leverage comes from capital, people, and products with no marginal cost of replication (code and media).
Capital means money. To raise money, apply your specific knowledge, with accountability, and show resulting good judgment.
Labor means people working for you. It’s the oldest and most fought-over form of leverage. Labor leverage will impress your parents, but don’t waste your life chasing it.
Capital and labor are permissioned leverage. Everyone is chasing capital, but someone has to give it to you. Everyone is trying to lead, but someone has to follow you.
Code and media are permissionless leverage. They’re the leverage behind the newly rich. You can create software and media that works for you while you sleep.
An army of robots is freely available – it’s just packed in data centers for heat and space efficiency. Use it.
If you can’t code, write books and blogs, record videos and podcasts.
Leverage is a force multiplier for your judgement.
Judgement requires experience, but can be built faster by learning foundational skills.
There is no skill called “business.” Avoid business magazines and business classes.
Study microeconomics, game theory, psychology, persuasion, ethics, mathematics, and computers.
Reading is faster than listening. Doing is faster than watching.
You should be too busy to “do coffee,” while still keeping an uncluttered calendar.
Set and enforce an aspirational personal hourly rate. If fixing a problem will save less than your hourly rate, ignore it. If outsourcing a task will cost less than your hourly rate, outsource it.
Work as hard as you can. Even though who you work with and what you work on are more important than how hard you work.
Become the best in the world at what you do. Keep redefining what you do until this is true.
There are no get rich quick schemes. That’s just someone else getting rich off you.
Apply specific knowledge, with leverage, and eventually you will get what you deserve.
When you’re finally wealthy, you’ll realize that it wasn’t what you were seeking in the first place. But that’s for another day.

Some links – 28 May, 2018

Trend: Rising (Investment) Protectionism

Trend: China Trying to Improve Financial Stability

Secretive Financial Group Unloads $3.5B Trust (CX, May-24) // Tomorrow Holdings Group

Investing

For investors, I’ve come to think of five levels of the game:
1. Apprentice — learning the game.
2. Expert — mastering the game you were taught.
3. Professional — making the game you were taught fit your own strengths and weaknesses.
4. Master — changing the game you play as part of your own self-expression and operating at scale. 5. Steward — becoming part of the playing field itself and mentoring the next generation

Technology

Artificial Intelligence—The Revolution Hasn’t Happened Yet (M) // Overview of the current state of AI, what’s missing and where it can go. Recommend reading in full.
To cut a long story short, I discovered that a statistical analysis had been done a decade previously in the UK, where these white spots, which reflect calcium buildup, were indeed established as a predictor of Down syndrome. But I also noticed that the imaging machine used in our test had a few hundred more pixels per square inch than the machine used in the UK study. I went back to tell the geneticist that I believed that the white spots were likely false positives — that they were literally “white noise.” She said “Ah, that explains why we started seeing an uptick in Down syndrome diagnoses a few years ago; it’s when the new machine arrived.”
Software 2018: Where We Are Now and Where Are We Going? (Battery Ventures) // Presentation with a good overview of software/SaaS industry. If you are interested in this space, you will want to carefully go through this deck.
 
The nightmare for the U.S. financial industry is that a technology company—whether from China or a homegrown juggernaut such as Amazon.com Inc. or Facebook Inc.—replicates the success of Alipay and WeChat in America. The stakes are enormous, potentially carving away billions of dollars in annual revenue from major banks and other firms. What follows is a breakdown of what that could look like—theoretically—using the explosive growth as China’s apps as a rough guide.

Policy

China and the International Order (RAND) –  This report evaluates the character and possible future of China’s engagement with the postwar order. The resulting portrait is anything but straightforward: China’s engagement with the order remains a complex, often contradictory work in progress.
Truth Decay (RAND) – Truth decay has four underlying trends: (1) Increasing disagreement about facts and data, (2) A blurring of the line between opinion and fact, (3) The increasing relative volume and resulting influence of opinion over fact, (4) Declining trust in formerly respected sources of factual information

 

Some links – April 10, 2018

Two interesting views on inflation: [1] Russell Napier’s view that Fed’s QT policy is decreasing money supply and therefore deflationary (along with other things), and [2] from 13D’s WILTW that Fed QT will be deflationary in theory but inflationary in practice.

Other things I’m reading or listening to:

 

A Man for All Markets (2017) Notes & Excerpts

In A Man for All Markets, Ed Thorp describes his life’s journey, from a prankster/tinkerer youth to beating the dealer in blackjack (and baccarat and roulette!) to successfully investing in derivatives, convertible arbitrage and other market-neutral systematic methodologies. Dr. Thorp is a pioneer in every field he’s touched, a real inspiration. After telling his life story, he gives some very solid practical advice for aspiring investors of any age. Of these, one of the best is making an annual balance sheet for your self/household to track your wealth creation over time.

Ed-Thorp-chance-and-choice-wp

Interesting facts about Dr. Thorp:

  1. He wrote a book about how to beat blackjack and invented card counting.
  2. He invented the Black-Scholes formula before Black-Scholes did.
  3. In his investing career, he compounded returns over 20% for many years.
  4. He created the first wearable computer to win at roulette.
  5. He worked with Claude Shannon, who was the founder of information theory that’s a foundation to our current IT Information Age.

Continue reading “A Man for All Markets (2017) Notes & Excerpts”