The streaming revolution is taking over. In the U.S., traditional media companies are merging and scrambling to catch up to Netflix, which invented the streaming concept and has a multiyear lead on rivals.
Meanwhile in China, each of the country's leading tech companies picked up on the streaming concept early. The early leader was iQIYI, which was partially spun out of Chinese search engine giant Baidu(NASDAQ: BIDU) last year. However, in 2017, Tencent(NASDAQOTH: TCEHY) Video passed iQIYI in terms of subscribers, though both are growing by leaps and bounds and are currently neck-and-neck for Chinese streaming supremacy.
So, which streaming leader – Netflix or iQIYI -- looks like the best bet today?
A young woman watches a show on her laptop listening to headphones and eating popcorn.
Image source: Getty Images.
Subscriber and revenue growth
Since both Netflix and iQIYI are growth companies, analysts often first look to their top lines. For Netflix, that means subscriber and revenue growth. Netflix has also been able to raise its prices in recent years, adding revenue above and beyond its mere subscription figures.
iQIYI, on the other hand, gets revenue from both premium subscribers and advertising from its free video offering. In that sense, iQIYI may be more like a mix of YouTube and Netflix, rather than a direct parallel.
Company
2018 Subscriber Growth
2018 Revenue Growth
Netflix (NASDAQ: NFLX)
25.8%
35.1%
iQIYI (NASDAQ: IQ)
72%
52.4%
Source: Netflix and iQIYI annual reports. Table by author.
Looking purely at the subscriber growth rates, it's clear that iQIYI is the winner here; however, there is more to the story.
Netflix has a mix of both domestic and international addressable markets. Netflix's domestic subscriber growth slowed in 2018 to just 11%, as it gets closer to U.S. saturation. On the other hand, Netflix's international segment surged 40%, matching the growth rate from a year earlier. Netflix had a subscriber base roughly twice the size of iQIYI's at the start of last year, so these lower growth numbers are still wildly impressive. In addition, the international segment's gains should sustain Netflix's overall growth at pretty high levels for the foreseeable future.
On the other hand, iQIYI also has some impressive underlying dynamics. Though its subscriber growth actually exceeded revenue growth, it wasn't due to price cuts. Membership revenue actually grew 72.3%, in line with subscriber growth.
The lower overall growth rate came from a lower advertising growth rate of just 21.2%. Advertising had been a larger part of iQIYI's base until last year, when subscription revenue surpassed advertising as the company's largest segment. Like Netflix, it appears iQIYI can sustain a high growth rate for the next few years at least.
Winner: iQIYI
Profitability (or lack thereof)
Of course, there's more to a company's value than its revenue growth. At some point, investors need to have a line of sight to profits.
With media companies, the costs of production can be a bit strange from an accounting perspective. Media companies usually capitalize their current content spend, and then amortize the portion of that "investment" that lines up with subscription revenue over the life of the show or movie. It's an imperfect system, but the total actual spend is still fully reflected on the cash flow statement.
For instance, Netflix, on a GAAP basis, is actually profitable. The company posted an operating profit of about $1.6 billion and an operating margin of just over 10% in 2018. That is infinitely better than iQIYI, which not only posted a negative operating margin of (33%) but a negative gross margin of (8.6%) in 2018 as well. That's right -- The company paid more for content, even on a capitalized basis, than it took in revenue.
Of course, Netflix is still posting negative free cash flow, as it outspent its content amortization in 2018 by about $5.5 billion. All in all, Netflix still posted negative operating cash flows of ($2.68 billion), for a negative (17%) operating cash flow margin. Meanwhile, iQIYI's operating cash flow minus content spend was roughly negative (40%) of revenue.
Winner: Netflix
Valuation
Since both companies are basically unprofitable, let's take a look at their price-to-sales ratios for valuation.
Netflix just reported first-quarter earnings and iQIYI hasn't reported yet, so let's go off their year-end 2018 sales. iQIYI currently trades for about 4.75 times 2018 sales, while Netflix trades at a much higher 10.6 times 2018 sales.
So, with higher growth and trading at less than half Netflix's valuation, iQIYI seems like the bigger bargain here.
But remember, while iQIYI may have a more exciting upside, it also comes with bigger risks. iQIYI is somewhat limited by its home market of China, while Netflix is aiming to take over the rest of the world. iQIYI is also in fierce competition with local giants Tencent and Youku Tudou, and is obviously spending huge amounts on content to compete. Meanwhile, Netflix is more profitable, and the clear leader in global streaming -- though it has emerging competitive concerns as well.
Therefore, risk-off investors should probably opt for Netflix -- though if you're a risk-off investor, you may wish to own safer, more profitable stocks than either of these two.
Billy Duberstein owns shares of Netflix. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Baidu, Netflix, and Tencent Holdings. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.
