Better Buy: iQIYI vs. Netflix

iQIYI (NASDAQ: IQ) is one of three major streaming platforms in China competing for more than 600 million viewers in the Middle Kingdom. The company has put up impressive numbers lately, but the stock is down 9% over the last year.

Netflix (NASDAQ: NFLX) has won over millions of viewers in the U.S. and is now looking to take its winning ways global. The stock soared more than 500% over the last five years but is up only 7% in the last 12 months, as the valuation may have gotten ahead of the company's actual performance.

Let's dig in to find out which one investors should buy today.

Plenty of growth to go around

The streaming wars are heating up in 2019 with new services launching from Apple and Walt Disney. Also, NBC and Discovery Communications are expected to launch their respective streaming services next year. The robust growth both iQIYI and Netflix are experiencing explains why these companies want in on the action.

First up, iQIYI's first quarter saw total revenue jump 43% year over year, while total paying members soared 58%. The company had 96.8 million paying members at the end of the first quarter.

Netflix isn't growing as fast, but its 22% revenue growth in the first quarter is nothing to sneeze at. Total paid subscribers worldwide increased 25% year over year, bringing the total patron count to 148.86 million at the end of Q1.

While iQIYI has been the faster-growing of the two lately, slowness in China's economy and delays in getting new content released will negatively impact iQIYI's growth in the short term. Management is calling for revenue to grow between 12% and 18% in the second quarter -- a steep deceleration from Q1. This is partly due to a slowdown in the company's online advertising business (about 32% of revenue in Q1).

On the other side, Netflix is forecasting growth to pick up in the second half of the year, stemming from the impact of price increases in the U.S., Brazil, Mexico, and parts of Europe, as well as a strong slate of new content launching later this year. All in all, management is calling for revenue growth to accelerate to 26% year over year in Q2, or by 32% excluding currency.

Despite iQIYI's soft near-term outlook, there's estimated to be at least 600 million people in China that watch streaming video, so iQIYI's growth should bounce back. For one, membership revenue growth was a robust 68% in the recent quarter, as more Chinese consumers are willing to subscribe instead of watching ad-supported free content.

Which is the better buy?

There are a few reasons why I believe iQIYI is the better buy.

First, iQIYI's historical growth has been much better than Netflix's, even though iQIYI is limited to the Chinese market while Netflix has growth opportunities around the world. But being limited to the Chinese market has forced iQIYI to build a more diversified business with several ways to drive growth.

Because of stiff competition with other streaming giants in China, such as Tencent Video and Alibaba's Youku Tudou, iQIYI can't raise prices the way Netflix can. Instead, iQIYI offers its users a range of other content services, including books and comics. The company also offers the Paopao entertainment-based social media platform, e-commerce channel iQIYI Mall, and online games, in addition to ad-supported content it offers users for free.

Another positive for iQIYI is that the company has been able to drive significantly faster growth in memberships while still generating free cash flow over the last three years.

On the other side, Netflix has burned $6.4 billion in cash over the last three years as the company spent billions on content. This aggressive spending has placed Netflix in a relatively weak financial position compared to iQIYI. Currently, Netflix has $7 billion of net debt (total debt minus cash). iQIYI is stronger with a net cash position of $314 million.

Finally, iQIYI stock is less expensive, trading for a price-to-sales ratio of 2.7 -- much cheaper than Netflix's 9.5 times sales.

Netflix has a bright future, but with debt and competition mounting in the short term, it doesn't seem like the best time to buy its shares -- especially with the stock trading at a relatively high valuation.

As for iQIYI, the stock has barely budged from its IPO price from April 2018, and the company is planning to ramp up investment in new original content and theatrical releases. The Chinese streamer is also investing in nifty technology like virtual reality to offer its users new ways to experience content. Looking beyond the short-term outlook, I believe these initiatives should drive growth in membership revenue for several years.

For all of these reasons, iQIYI looks like the better buy for investors today.

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John Ballard has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple, Discovery (C shares), Netflix, Tencent Holdings, and Walt Disney. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool recommends Comcast and iQiyi. The Motley Fool has a disclosure policy.