Overview

This submit serves as an replace to my coverage in September.

I nonetheless suppose iQIYI, Inc. (NASDAQ:IQ) is underappreciated. I anticipate elevated transparency on IQ's supply of constructive OPM as administration shifts its focus to profitability and effectivity by optimizing content material prices and OPEX and adjusting its content material investment-centric income progress methods. Nevertheless, I proceed to be cautious of IQ's subscription income progress, because the constructive affect of an bettering common income per member in a comparatively steady pricing setting is offset by gradual subscription progress. The continued time-spent share loss to SFV (short-form movies) platforms, tightened laws, and COVID's resurgence all have the potential to additional delay the promoting trade's capacity to recuperate.

Efficiency assessment

IQ’s share value has declined by 27.25% since my preliminary submit, which is clearly not the end result I used to be in search of, however it's not out of my expectations given the uncertainties in China.

Earnings assessment

IQ's results have been higher than anticipated, with elevated income, constructive working and internet revenue margins (7% working margin), and constructive free money circulate for the primary time in a number of quarters. I am relieved to listen to this, because it exhibits that administration is keen to see income enhance via their efforts to chop prices (word that this was one among my key thesis factors).

Here's a rundown of the latest earnings:

1. Income was down -2% to Rmb7.5 billion, however that was nonetheless 2% above projections.
2. The typical variety of every day subscribers for membership companies is now 101 million, up 2.7 million from the prior quarter, and the typical income per paying person (ARPU) is now RMB 13.9 million monthly.
3. Due largely to troublesome macroeconomic situations, income from internet advertising companies dropped by 25% to RMB1.2 billion. However, for my part, that is a lot better than the 35% drop in 2Q22.
4. Income has elevated by 27% due to a profitable collaboration with Douyin. For my part, that is massive information as a result of it may spur an increase within the common IQ of the inhabitants.
5. The corporate's non-GAAP working revenue for the quarter was RMB524.3 million, up from a lack of RMB1.1 billion in the identical interval a 12 months in the past.
6. That is the primary quarter of constructive FCF and the second consecutive quarter of constructive working money circulate.

Membership income performing properly

Paid memberships Common every day customers jumped to 101 million, up 2.7 million from the earlier quarter. The excellent news is that, for the primary time in 4 years, September noticed a rise in subscribers. That is attributable to 3 components: 1) elevated advertising efforts starting in late August; 2) higher-quality premium content material, particularly authentic content material; and three) enhanced membership perks on account of the macroeconomic restoration. Along with a rise in quantity, ARPPU rose to Rmb13.9 monthly on account of elevated promotional reductions provided through the summer season months.

Administration has expressed optimism in regards to the future, saying that the third-quarter end result doesn't precisely replicate IQ's sturdy progress momentum and that subscriber progress and will increase in common income per person would be the main drivers of the membership companies enterprise. So long as IQ maintains its concentrate on producing high-quality, authentic programming, it ought to see an increase in its subscriber base. I've little question that that is potential due to IQ's novel method to content material creation, backed by expert groups from the in-house studio, a mature and environment friendly full-cycle manufacturing mechanism, and an clever manufacturing system designed to spice up each high quality and productiveness. Alternatively, ARPPU progress is generally attributable to two issues: decreasing promotional reductions and enthusiastic about value hikes.

On-line advertisements income carried out higher than anticipated in a foul setting

Due primarily to troublesome macroeconomic situations, income from internet advertising companies dropped by 25% to RMB1.2 billion. However, for my part, that is a lot better than the 35% drop in 2Q22. In the event you look previous the headline numbers, you will see that model promoting income, particularly advert demand from worldwide model advertisers, improved throughout the newest quarter, and efficiency promoting income elevated each yearly and through the newest quarter.

Future advert income progress for IQ will likely be hampered by macro headwinds, however I count on it to select up a bit in 4Q22 due to a mix of a macroeconomic uptick and the launch of some new selection exhibits in 2H22 that ought to assist increase IQ's model promoting.

On observe for extra profitability and constructive FCF

Compared to a lack of Rmb1.1 billion in the identical interval a 12 months in the past, the corporate's non-GAAP working revenue for the quarter was Rmb524.3 million. Elevated effectivity in managing content material prices, a 21% drop in SG&A prices, a 30% drop in R&D prices, and a 5% drop in IQ's share of compensation prices are primarily answerable for this.

For the reason that firm modified its technique to "Calm Development" in 3Q22, which will likely be supported by persevering with cost-cutting initiatives and elevated top-line contribution beginning in 3Q22, administration expects the pattern in free money circulate ("FCF") to proceed.

For me personally, as an investor in IQ, listening to that the corporate will quickly be producing constructive money circulate is like music to my ears.

Mannequin replace

My mannequin has been up to date to raised replicate FY22 income and to permit for the early realization of constructive FCF. I nonetheless suppose that IQ is undervalued and that the selloff is simply resulting from "risk-off" conditions within the close to future.

With my new assumptions, I imagine the IQ upside stays interesting.

Conclusion

I nonetheless suppose that iQIYI, Inc. has an opportunity to go up. However I am nonetheless anxious about IQ's subscription income progress as a result of, despite the fact that the typical income per member goes up in a pricing setting the place costs aren't too excessive, subscription progress is gradual. With time-spent share nonetheless going to SFV platforms, laws getting stricter, and COVID making a comeback, the timeline for advert restoration may get even longer.