iQiyi takes over the lead in Chinese streaming

There are three major subscription video providers in China: iQiyi (NASDAQ: IQ), Tencent (OTC: TCEHY) Video, and Youku Tudou, which belongs to Ali Baba (NYSE: BABA). iQiyi had been the first streaming leader, but in recent years, social media and gaming powerhouse Tencent has overtaken iQiyi. Alibaba’a Youku is also a serious competitor, but it does not disclose its paid subscribers – although Alibaba revealed around 30 million subscribers at the end of 2016.

But as recent earnings reports have shown, iQiyi has once again assumed the throne. Here is a recent history of the Chinese streaming fight, and how investors should play it.

Image source: Getty Images.

Shoulder to shoulder

The video streaming war is fierce in China. Although the Chinese people have traditionally been averse to paying for entertainment, these three tech giants have likely seen the success of Netflix (NASDAQ: NFLX) across the Pacific and followed suit.

Investment in streaming video is also very capital intensive, and the industry has rapidly consolidated around the three richest players. Alibaba bought Youku Tudou at the end of 2015, iQiyi was incubated by the search engine giant Baidu (NASDAQ: BIDU), and Tencent Video came out of the gaming giant and WeChat creator Tencent.

The battle became so intense that Baidu sold part of iQiyi in a partial IPO in the US market in early 2018 to fund content spending. That money probably went to investing in 2018, which may be why iQiyi has just taken the lead:

Two lines showing iQiyi and Tencent video sub-accounts over time since 2015.

Data sources: company files, press releases, conference calls. Chart by author.

Content generates subscriptions

It’s entirely possible that iQiyi’s recent push is tied to a bigger investment in content. However, Tencent does not separate the financial data of its video business from the rest of its content on ad-supported video and music subscriptions, so it is difficult to compare with “pure play” in iQiyi. Still, the fact that iQiyi gained 10 million subscribers quarter over quarter while Tencent’s paid subscribers were mostly flat indicates something is up.

iQiyi reported a number of content drops in the last quarter that could have allowed it to move forward. CEO Yu Gong said the conference call with analysts:

In terms of premium content, we have released several high quality originals [dramas] during the quarter, as The legend of Haolan, Golden eyes, [and] The legend who quickly saw [subscriber] growth. Licensed dramas such as Minglan’s story, All is well and I will never let you go also contributed to [subscriber] conversion as we granted [subscribers] early access to watch. … [W]e have been privileged [with] our value-added services to members, which have helped further drive subscriber growth.

Meanwhile, it looks like Tencent Video has rescheduled some of its best drama series from Q1 to later this year, with CEO Pony Ma saying: “[W]We haven’t added some top drama series that we intended to air in Q1[,] reducing our advertising inventory of video products and negatively impacting our overall media advertising revenue. ”

Subscribers are nice, but what about the profits?

Even though iQiyi appeared to invest more in content than Tencent in the past quarter, iQiyi’s content costs only increased about 38% year-over-year, which is well below its 64% growth in membership revenue. Management also revealed that content costs have been declining sequentially.

For their part, Tencent management said that “the biggest players in the online video and streaming video industry have generally become more cost conscious over the past six to nine months.” Tencent, of course, doesn’t stream individually, so it’s hard to say whether its video platforms are profitable overall.

However, we do know that iQiyi is definitely not profitable, as it lost 1.8 billion yuan ($ 270.3 million) in the first quarter alone. iQiyi has apparently spent more than its rivals on a relative basis to regain the lead in streaming in China.

While streaming stocks in general have performed quite well, it remains to be seen how profitable they will ultimately be. Although iQiyi has done an admirable job of competing, the company continues to post heavy losses. Meanwhile, Tencent on the whole is much more profitable, thanks to its gaming and social media network, which iQiyi does not have.

So while iQiyi has taken the lead on streaming subscribers, history shows that can change, so I would always go with Tencent’s more conservative game.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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