Baidu's (NASDAQ:BIDU) iQiyi unit, a provider of online video steaming services in China, has plans to raise funds via an initial public offering (IPO) in the next three years. iQiyi’s CEO, Gong Yu, said during an interview in late April that the company is aiming for the largest market share and revenue share in China by the time of the IPO, per a Bloomberg report. If this happens, iQiyi’s valuation will surpass that of its closest rival, Youku (NYSE:YOKU) (market cap: $3.7 billion and annual revenues: $479 million).
iQiyi was acquired by Baidu in 2012. The company went on to acquire PPStream, another major online video service in China, for $370 million in 2013 to become the largest online video platform in China by number of mobile users and video viewing time. According to data published by consulting group iResearch, iQiyi overtook Youku as the most popular video service by monthly active users this year. iQiyi had 94 million monthly active users in January as compared to Youku’s 83.5 million.
We are encouraged by these recent developments since the Chinese online video market is forecast to grow at a brisk pace of 30% for the next four years to become a $6 billion market by 2017. Further, it is a good diversification strategy for Baidu, whose business has been heavily dependent on search offerings to generate revenues. However, there are also certain challenges that iQiyi must overcome.
First, advertising accounts for over 75% of the revenues of China’s online video market, as selling content to viewers is difficult due to piracy issues. Monetization through the sale of content is an important revenue stream that the industry is not able to capitalize on, more so because licensing content from producers is expensive in China. In 2013, Baidu’s content costs increased to 2.6% of revenues ($5.3 billion) from 1% in the prior year primarily because of iQiyi, the company said in its Q4 earnings call. Second, iQiyi has not yet approached profitability, and we think that it may have to produce more in-house videos to become profitable, despite the strong growth that is expected in the video market. Margins on in-house videos are higher than that on licensed videos. And third, Youku recently received a $1.2 billion from Alibaba, which has the financial resource to grow Youku into a leader in online video streaming.
We have a price estimate of $175 for Baidu, almost in line with its current market price.
Disclosure: No positions.