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Chinese video streaming company iQiyi, known as China's Netflix is set to go public Thursday on the Nasdaq under the ticker IQ and expected to raise $2.375 billion, the biggest IPO since Snap's $3.4 billion last year. Baidu $BIDU is the majority owner.

IQIYI

The IPO will also be larger than PagSeguro Digital's $PAGS $2.27 billion IPO in January and last week's successful Dropbox $DBX IPO.

iQiyi $IQ raised $2.25 billion late Wednesday with the initial public offering priced nearly 125 million shares at $18 at the midpoint of the expected range of 17 to 19 a share.

Shares in iQiyi Inc $IQ opened at $18.20, slightly ahead of the $18 initial public offering price. By mid afternoon at at 2:44 PM EDT the price had fallen to $16.88 USD -1.12 -6.22%

IQ Day One

 The IPO

  • $IQ plans to offer 125 million American depository shares at a price range of 17 to 19.
  • The company will list under the symbol $IQ on the NASDAQ
  • Chinese search leader Baidu (BIDU) is the majority owner of iQiyi,
  • The company has been referred to as the Netflix (NFLX) of China.
  • With 50 million subscribers, iQiyi has nearly 28% market share in China,
  • Rivals Alibaba $BABA and Tencent $CEHY$ have their own streaming services 

The previous biggest deal was Brazilian fintech PagSequro Digital Ltd.’s $PAGS $2.27 billion deal in January.$IQ would be the highest-value IPO since Snapchat parent Snap Inc. $SNAP went public last March in a $3.4 billion deal.

Underwriters

Goldman Sachs (Asia), Credit Suisse, Bank of America Merrill Lynch, China Renaissance, Citigroup and UBS have an option to sell an additional 18.75 million shares.

About iQiyi

iQiyi $IQ was created in 2010, and has since grown to be the largest internet video streaming service in China , measured by monthly average users (MAUs) in 2017, according to Chinese third-party research firm iResearch per their prospectus.

The company had 60.1 million subscribing members as of Feb. 28, more than 98% of which were paying subscribers. By comparison, Netflix Inc. $NFLX had roughly 53 million paying subscribers in the U.S. in the fourth quarter, and 58 million overseas subscribers.

For the three months ending with December, iQiyi had average mobile MAUs of 421.3 million and about 126 million average mobile DAUs (daily average users). In December alone, members watched 9.2 billion hours of video on the platform and spent an average of 1.7 hours a day on its mobile apps.

The company makes its money from subscription fees, advertising on the platform and content distribution. Proceeds of the IPO are to be used to expand content offerings and strengthen technologies and for working capital and other general corporate purposes. But the IPO is also intended as a way to get the brand name better known and attract and retain employees by offering them equity awards, according to the prospectus.

iQiyi’s original content is popular in China, accounting for six of the top 10 original internet drama series in the country in 2017, according to iResearch. “The Lost Tomb,” a high-budget drama series released in 2015, drew more than 100 million video views in the first 24 hours of release, and has generated more than 4 billion views in total.

$IQ also produces internet variety shows, including “The Rap of China,” an “X Factor”–style rap reality show and competition, which has generated more than 3 billion video shows.

Video is the leading online entertainment format in China, accounting for more than 80% of the time spent online, and the number is expected to grow as more consumers come online. China’s internet video users have grown to 545 million in 2016 from 372 million in 2012, and that number is expected to grow to 766 million by 2022, according to the prospectus.

The Risks of Investing in IQ

Baidu will remain in control

The company has a dual-share-class structure, and Baidu $BIDU will own all of the company’s higher-voting-rights Class B shares once the offer is completed.  Meaning despite going public $BIDU will remain$IQ’s controlling shareholder, with more than 93% of voting rights.

Analysts so far see this as a positive, as Baidu is one of China’s better-known names and is a key technological partner for iQiyi.

However, “Baidu’s voting control may cause transactions to occur that might not be beneficial to you as a holder of ADSs and may prevent transactions that could have been beneficial to you,” the company cautions in its prospectus.

 iQiyi has an unusual risky corporate structure

Chinese companies listings outside of China favor variable-interest entity, or VIE as a structure created in the 1990s as a workaround for Chinese companies not allowed to have direct foreign ownership. This is what $IQ is.

Under the VIE structure, the Chinese company creates two entities, one in China that holds the permits and licenses needed to do business there and the other an offshore entity, in this case in the Cayman Islands, in which foreign investors can buy shares. The Chinese entity, which is usually owned by top executives, pays fees and royalties to the offshore company in contractual arrangements.

The biggest example of a VIE is Alibaba Group Holding Ltd. $BABA in which the Chinese entity is wholly owned by its founder and chairman, Jack Ma. The risk with this set-up is that foreign investors don’t actually own stock in the company, and local management or even the Chinese government could decide or force a split with the listed company, leaving U.S. investors empty. Not out of the realms of possibilities with the U.S.. slapping $60 billion worth of tariffs on China. 

The iQiyi prospectus acknowledges that risk: “If the PRC (People’s Republic of China) government finds that the agreements that establish the structure for operating certain of our operations in China do not comply with PRC regulations relating to the relevant industries, or if these regulations or the interpretation of existing regulations change in the future, we could be subject to severe penalties or be forced to relinquish our interests in those operations.” '

iQiyi has NEVER made a profit

While iQiyi is growing revenue fast, up to $2.67 billion in 2017, or 55%in a year. It has the cash burn problem that $NFLX has. $IQ lost $574 million last year, up 22% from the prior year.

The prospectus projects this burn to go on for a while yet. $IQ's cost of revenue was $2.67 billion in 2017, the same as its revenue. Content costs rose 67% to $1.94 billion, and bandwidth cost rose 17% to $336 million.

The company is expecting cost of revenue to continue to grow and to exceed revenue growth at least in the near term. “

We face significant competition in China, primarily from Tencent Video and Youku Tudou,” according to the prospectus.

“We compete for users, usage time and advertising customers. Some of our competitors have a longer operating history and significantly greater financial resources than we do. If any of our competitors achieves greater market acceptance than we do or is able to offer more attractive video content, our business, financial condition and results of operations may be materially and adversely affected.”

The company does not intend to pay a dividend in the near future, so shareholders will rely entirely on the ADS appreciating in price.

The Burn Rate means iQiyi Will Need More Funding SOON

“Producing high-quality original content is costly and time-consuming and it will typically take a long period of time to realize returns on investment, if at all,” said the prospectus.

Like Netflix, iQiyi relies heavily on algorithms, artificial intelligence and user data to select third-party content and has built a substantial library.

The huge positive here is Baidu providing it technology, infrastructure and financial help. BUT the prospectus states, “we have no experience operating as a stand-alone public company. After this offering, we will face enhanced administrative and compliance requirements, which may result in substantial costs.”

Be prepared and be sure this is the risk you want to take on.

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