What Lies Ahead For Baidu’s Online Video Business

by Trefis Team
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China is a booming market for internet companies owing to the huge potential customer base in the country. The number of total internet users in China has grown from around 140 million in 2006 to over 730 million by the end of 2016 – a CAGR of around 18% – while internet penetration has increased from 10% of the population a decade ago to over 50% in the same period. There are roughly 730 million total internet users in China, according to recent estimates, which was roughly equal to the number of internet users in the next two countries on that list – India (462 million) and the U.S. (287 million)

Since internet penetration in China is still only around 50%, a huge section of the potential market is still untapped. As a result, Chinese internet companies have expanded massively over the last decade with the e-commerce, online video streaming, social media  and online payment market segments providing much of the growth for internet companies. In this article we take a look at the online video streaming market in China and where Baidu’s (NASDAQ:BIDU) iQiyi stands in this fast-growing market.

Landscape Of The Chinese Online Video Market

Increasing average internet speeds and growing internet penetration in China in recent years have led customer demand to transition from television to online video streaming. This trend is likely to continue in the coming years, with the online video streaming market size expected to grow at a CAGR of over 35% through the end of the decade. Consequently, Chinese internet companies such as Baidu, Alibaba (NYSE:BABA) and Tencent Holdings have ventured into the domain to gain a strong foothold in this market.

Baidu founded iQiyi with American private equity firm Providence Equity Partners in 2010, before buying out Providence’s stake in 2012. iQiyi is currently one of the largest video streaming businesses in China with over 500 million monthly viewers. Among these users, Baidu reported that only about 20 million users were paid subscribers.

In addition, Youku Tudou, Tencent Video and LeTV.com have a solid presence in this market. Youku Tudou was formed by the merger of internet sites Youku and Tudou in 2014, and was subsequently acquired by Alibaba for around $4 billion last year. Last year Alibaba reported that Youku Tudou had around 30 million paid subscribers for the video platform. Around that time, Tencent Video also reported around 20 million paid subscribers to its service.

Needless to say, there is significant competition in this market, with some of these players signing exclusive deals with foreign content providers. Moreover, since China is a fairly restrictive market for foreign companies, it gives an added push to these companies as they don’t have to compete with international players – in this case Netflix (NASDAQ:NFLX) – in the domestic market. Late last year, Netflix announced that it will no longer pursue the idea of launching its own service in China. Subsequently, Netflix signed a licensed deal with Baidu to stream its original content on Baidu’s iQiyi video portal. Similarly, Tencent Video signed an exclusive deal with HBO to stream its premium content for Chinese audiences.

Monetizing The Online Video Streaming Business

While Chinese online video streaming services have expanded both in size and in reach, the total revenue generated from advertising revenues has seemingly saturated at the moment. The total “impression-based” advertising volume can only increase to a point before impacting the user experience. As a result, companies are looking to target a subscription-based business model to help sustain revenue growth. One of the ways to that is to stream exclusive content – such as Netflix’s – on their video platforms.

In addition, many online video streaming companies have also begun creating original content, similar to what Netflix has been doing over the years. Original content varies from TV shows, movies, documentaries as well as live sports. However, creating original content and signing exclusive license agreements requires major upfront expenditures. The idea is to gain a meaningful customer base in the early years while operating at a loss, with the intent to monetize them more effectively in future years.

Baidu’s Presence In The Market

Baidu’s online video business includes its iQiyi video platform, which has an extensive video content library that includes licensed movies, television series, cartoons, variety shows and other programs. In addition to sourcing licensed content, iQiyi also produces a wide array of original content and provides online community services to facilitate user communication and interaction. iQiyi’s revenues have grown at at CAGR of almost 100%, from $220 million in 2013 to $1.6 billion in 2016. As a result, online video revenues have become more meaningful to the company’s top line in the same period, as shown below.

bidu_iqiy3

While revenues have grown considerably in this period, the company has operated the segment at a loss. The operating costs for Baidu’s online video segment consist primarily of content acquisition costs, bandwidth costs, and other SG&A and marketing expenses. Consolidated operating expenses for the iQiyi segment (adjusted for inter-segment expenses) have increased from $340 million in 2013 to almost $2 billion in 2016. While the company has operated this segment at a loss over the last few years. the growth rate of operating expenses has been slower than the revenue growth, as shown below.

bidu_iqiy4

Baidu’s online video revenues grew at a pace that was more rapid than the market growth rate. The online video market in China grew at a CAGR of over 40% from $2.2 billion in 2013 to almost $9 billion in 2016. Over this period, Baidu has not only made large expenditures to acquire premium copyrighted movies and television shows, it has also produced original content exclusive to its platforms and affiliated third party platforms. As a result, its share in the market grew from under 10% in 2013 to 18% in 2016.

bidu_iqiy1

 

We forecast iQiyi’s revenue growth to continue to outpace the market in the coming years. We forecast iQiyi revenues to grow at over 30% annually to reach almost $6 billion by the end of the decade. In the same period, the Chinese online video market could be a $30 billion market, according to an iResearch China estimate. [1]

 

bidu_iqiy2

Moreover, we expect the business to generate positive margins in the long run for two primary reasons. Firstly, most of iQiyi’s bandwidth costs are fixed in nature, which means that these costs may not increase with revenue gains. Secondly, high content acquisition costs are unlikely to increase at the same rate as revenue growth, owing to economies of scale. We currently forecast Baidu’s online video segment to report an operating profit starting in 2018.

 

You can modify the interactive charts in the article to gauge how a change in the Chinese online video market, Baidu’s market share or its EBITDA margin can have on our price estimate for the company. According to our estimates, the online video division makes up approximately 14% of our $171 price estimate for Baidu’s stock. Our price estimate is slightly lower than the current market price.

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Notes:
  1. China Online Video Market 2o16, iResearch China, February 2017 []
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