Better Streaming IPO: Spotify or iQiyi?

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Overseas streaming giants iQiyi (NASDAQ: IQ) and Spotify (NYSE: SPOT) both recently went public in the US. iQiyi, one of the top video streaming services in China, went public at $18 on March 22, but it tumbled nearly 14% on the first day and remains below its IPO price.

Sweden-based Spotify, which owns the top subscription-based music streaming service in the world, made its public debut at $132 on April 3. The stock rallied 12% on the first day, but it remains at that level as of this writing.

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Investors might be wondering if either streaming leader is a worthy long-term investment at these levels. Let's take a closer look at both businesses to find out.

How do iQiyi and Spotify make money?

iQiyi was previously a subsidiary of Baidu (NASDAQ: BIDU), which still owns nearly 70% of the new company. iQiyi offers streaming video from China and international markets through licensing and production deals with companies like Lions Gate, Paramount, Netflix (NASDAQ: NFLX), and Japan's Fuji TV.

iQiyi operates on a freemium model. Users can watch free ad-supported content, buy a la carte programs, or buy paid subscriptions for ad-free content and exclusive programming. iQiyi's subscriptions only cost 20 RMB ($3) per month, which is comparable to its domestic rivals. iQiyi's membership revenues accounted for 37.6% of its total revenues last year, up from 33.5% in 2016.

Spotify also uses a freemium model. It plays ad-supported streams for free users and offers a premium subscription tier that eliminates ads and adds personalized features for $10 a month. Spotify generated 90% of its revenues from subscriptions last year, which was roughly unchanged from 2016.

Spotify is available in 65 markets, but its largest market is the U.S., which generated 39% of its revenues in 2017. It owns a catalog of over 35 million songs, which are curated across two billion playlists.

How fast are iQiyi and Spotify growing?

iQiyi finished last year with 424.1 million PC monthly active users (MAUs). Its mobile MAUs rose 4% annually to 421.3 million, while its paid subscribers soared 68% to 50.8 million. Daily average user hours spent on the platform climbed 16% to 300.1 million, and its mobile users spent an average of 1.7 hours watching videos per day.

iQiyi's online ad revenues rose 44% to 8.16 billion RMB ($1.25 billion) last year as its membership revenues grew 74% to 6.54 billion RMB ($1 billion). iQiyi's total revenues rose 55% to 17.38 billion yuan ($2.67 billion) for the year, which marks a slowdown from 111% sales growth in 2016.

Spotify's premium subscribers rose 46% to 71 million last year. Its total monthly active users (MAUs) rose 28% to 159 million. Its total content hours streamed rose 51% to 40.3 billion in 2017. Spotify claims that its free, ad-supported service drove "more than 60%" of its new premium subscriptions since early 2014.

However, Spotify's average revenue per premium user fell 14% to 5.32 euros ($6.53) in 2017 due to the expansion of its multiuser Family Plan and foreign exchange rates. Spotify's total premium revenues rose 38% to 3.67 billion euros ($4.5 billion) last year, as its ad revenues climbed 41% to 416 million euros ($511 million). Its total revenues rose 39% to 4.09 billion euros ($5.02 billion) last year, but that also marked a slowdown from its 52% growth in 2016.

How profitable are iQiyi and Spotify?

iQiyi and Spotify both face tough competition. iQiyi's main competitors in China are Tencent Video and Alibaba's Youku Tudou. Spotify's main rivals include Apple Music, which hit 36 million subscribers earlier this year, and Pandora Media, which has nearly 75 million listeners but only 5.5 million paid subscribers.

Both companies are also struggling with high content licensing costs. Those two headwinds make it tough for either company to squeeze out a profit. iQiyi's net loss widened from 3.07 billion yuan to 3.74 billion yuan ($574.4 million) last year.

Spotify's net loss widened from 539 million euros ($662 million) to 1.24 billion euros ($1.52 billion). Its EBITDA loss also widened from 311 million euros ($382 million) to 324 million euros ($398 million). Neither company has offered investors a clear roadmap toward profitability.

The valuations and verdict

iQiyi trades at about 4 times its trailing sales, while Spotify trades at just over 5 times sales. Both price-to-sales ratios are much lower than Netflix's price-to-sales ratio of 11. However, investors are paying a premium for Netflix because its sales growth remains stable, it only generates higher-margin revenues from subscriptions, and it's profitable.

iQiyi and Spotify are both struggling with slowing sales growth, widening losses, high content licensing costs, and tough competitors. Therefore, I'd avoid both stocks until I spot some signs of improvement.

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Leo Sun owns shares of Apple, Baidu, and Tencent Holdings. The Motley Fool owns shares of and recommends Apple, Baidu, Netflix, Pandora Media, and Tencent Holdings. 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 has a disclosure policy.