INSIGHTS | Short seller huffs and puffs, but it doesn’t blow Iqiyi down

It has been one month since short seller Wolfpack Research accused Chinese video-streaming platform Iqiyi of inflating 2019 revenue by up to 40%. Iqiyi has provided no solid evidence to defend itself besides an indignant statement denying all the accusations, but neither has it made a sudden confession like fellow short-seller prey Luckin Coffee.

Investors still seem optimistic about the company, and shares are around where they were before the report. Is this a case of “fool me twice”? Or is there a better case for Iqiyi than there was for the hot drink humbugs?

A glancing blow: The share price of Iqiyi dropped only briefly by up to 11.2% when Wolfpack dropped the report on April 7 morning, and ended the day up 3.2%. In the following month, shares of the company fluctuated within a normal range, and now are at about the same level as before the report was released.

Like Luckin? Shares of Luckin Coffee behaved similarly after the first accusations surfaced in a report made public by short seller Muddy Waters in early February, wobbling without a sharp move. The nosedive came after the company made a surprise confession on April 2 that several employees, including its COO, had fabricated transactions for much of 2019, amounting to an estimated RMB 2.2 billion (around $311 million) in falsified sales. Shares of the company were wiped out by nearly 80% the same day.

What did the short report say? In a report published April 7 and tweeted by Muddy Waters, Wolfpack claims that Iqiyi had inflated its 2019 revenue by between approximately RMB 8 billion to RMB 13 billion, or 27% to 44%.

• The report argues that Iqiyi overstated its user numbers by around 42% to 60% to justify inflated revenue.
• It also claims that Iqiyi has exaggerated its expenses, including prices it pays for content, other assets, and acquisitions “in order to burn off fake cash to hide the fraud from its auditor and investors.”
• The report cited a handful of sources of its own, including a former Iqiyi employee and two Chinese advertising companies. By comparison, the report against Luckin claimed that it had mobilized 92 full-time and 1,418 part-time staff “on the ground” to run surveillance of 620 Luckin stores across the country.
• Wolfpack’s 37-page report, however, often bases its conclusions on hasty generalizations, and sometimes, on flimsy sources and comparisons of apples and oranges.

What did Iqiyi say? Iqiyi said in a statement on April 8 that the report “contains numerous errors, unsubstantiated statements and misleading conclusions and interpretations.” But the company didn’t provide any details to back up its claims.

• One month on, Iqiyi has yet to provide an update on its claims. The company told TechNode Friday it doesn’t have further comment on the report.
• The investor community has expressed their disappointment with the company’s lofty disdain. “If they [the management of Iqiyi] don’t step it up and respond and take things seriously, you kind of wonder, should investors trust them? Why should investors trust them?” said James Hull, analyst and portfolio manager at Hullx Capital, at a TechNode webinar on April 23. 
• “I think they should come back with a very detailed response, and hopefully they are working on that right now,” said Hull.

Problems with the Wolfpack report: Iqiyi may have a reason for its faint response: Wolfpack’s report has serious flaws in evidence and reasoning. It’s sloppy, too, about details, wrongly listing the cities of Guangzhou and Shenzhen among China’s four provincial-level metropolises. Guangzhou and Shenzhen are both in the province of Guangdong.

Over-generalization: In places, Wolfpack goes out on a limb to find figures to debunk. I’m not entirely convinced that Iqiyi ever really made some of the claims Wolfpack tries to disprove.

• Data provided by the two ad companies showed that the Iqiyi’s average mobile daily active users (DAUs) was 24.7 million in China’s 19 tier-1 cities in four days in September 2019. 
• Wolfpack then quoted two promotional reports by the company and a keynote speech by a company executive, extrapolating from them to produce an estimate that Iqiyi has “62.29 million DAUs in China’s tier 1 cities.”
• Wolfpack’s argument that Iqiyi inflated user numbers by 60% is an extrapolation from a single four-day period.
• The two promotional reports are not official filings to the US Securities and Exchange Commission; they’re just Iqiyi’s reports on China’s online movie industry in 2018 and 2019.

Comparison of apples and oranges: 

• Wolfpack quoted a report by market research firm QuestMobile in February as saying that Iqiyi’s average mobile DAUs were 126.2 million during the first 10 days of the 2020 Chinese Lunar New Year, comparing it to an Iqiyi claim of 180 million average DAUs in 2019.
• Wolfpack drew the conclusion that the company “overstates its DAU numbers by at least 42%.”
• But the 180 million figure is for all DAU across platforms, not mobile DAU. Iqiyi only said its average mobile DAUs were 139.9 million in its 2019 annual report, a difference of just under 10%.
• DAUs of video platforms vary from time to time. Video platforms usually saw their DAUs surge when a popular show was on. 

Problems with Iqiyi: Iqiyi certainly has real problems. It is often called China’s Netflix, and to some extent, it is. The company earns more than half of its revenue from paid membership services in the fourth quarter of 2019. However, memberships are not a profitable business yet, while other sources of revenue are in decline.

• Iqiyi said in its 2019 annual report that the company’s average mobile monthly active users (MAUs) were 476 million in the year. The company also said it has around 106 million paying subscribing members as of the end of last year, meaning only 22.3% of its MAUs were paying for its content.
• Revenue brought by the small proportion of paying users is not enough to cover its content expenses. The company earned RMB 3.9 billion from membership services in the fourth quarter. Nonetheless, it spent RMB 5.7 billion on content costs in the same period.
• “Content production in China is kind of a cash incinerator,” said Hull at the Webinar. “I don’t see any significant franchises that Iqiyi can create like Disney can create.”
• The losses from the gap between content cost and subscription revenue are partially made up by advertising revenue—thanks to its large proportion of free users—which accounted for 25% of Iqiyi’s Q4 revenue. 
• The company said its ad revenue was down 15% year on year in the quarter and attributed the drop to a “challenging macroeconomic environment in China.” What the company hasn’t mentioned here is rivalries from short video platforms such as Douyin and Kuaishou. Bytedance, the owner of Douyin, overtook Iqiyi-parent Baidu in 2019 to hold the second-largest share of China’s digital ad market, according to Totem Media.

Conclusion: Iqiyi is not Luckin, but neither is it Netflix. There’s no solid evidence of fraud, and there’s clearly a real business there. But by ordinary business metrics, it could well be overvalued. Iqiyi is not going to zero, but it could be headed for a drop.

Correction: An earlier version of this article, which appeared in TechNode’s Distilled newsletter on May 9, incorrectly stated Iqiyi’s content expenses as RMB 5.7 in the fourth quarter of 2019. The company’s content costs for the quarter were RMB 5.7 billion.