Shares in iQiyi (Nasdaq: IQ) were trading down 15% Friday afternoon on news that it’s under investigation by the Securities and Exchange Commission.
If the Luckin Coffee scandal has taught us something this year, it’s to be skeptical of Chinese companies, even giant ones taking strides towards dominating its market.
IQiyi strives to be China’s Netflix (and even Disney, as its founder has said once) and is one of the country’s top entertainment streaming platforms. The company has just posted $1 billion in revenue for the second quarter, though it continues to incur losses. Meanwhile, it was among a number of U.S.-listed Chinese firms hit by short-seller reports this year.
In early April, Wolfpack Research published a report, titled “IQIYI: The Netflix Of China? Good Luckin.” The research firm alleged that iQiyi has inflated its books before its public offering in 2018 and after, and “is unable to legitimately grow their business enough to true up their financial statements.” Specifically, Wolfpack claimed that in 2019 iQiyi overstated its user numbers by 60%, which in turn falsely bolstered its revenue by up to 13 billion yuan, or 44%.
The notorious short-seller Muddy Waters shorted iQiyi at the time and said it helped Wolfpack in building the report. Muddy Waters stated in a Tweet that iQiyi "fraudulently and materially overstates its users, revenues, acquisition consideration, and value of its 'barter' content."
As a result, the stock in iQiyi traded below $17 in early April, down from its peak of $27.50 in mid-February. The April lows preceded an uptrend to $19.28 per share, then followed a jagged curve until mid-June, spurred by news that a former Netflix executive for its international business, Yu-Chuang Kuek, joined the company. Further, reports surfaced that tech conglomerate Tencent (HKEX: 0700; OTC: TCEHY) seeks to acquire iQiyi in a slew of acquisition deals the giant has recently made in the internet space.
Ironically, Yu Gong, the founder and chief executive officer of iQiyi, viewed Tencent as its biggest competitor, as he told CapitalWatch in an interview shortly after its listing. Tencent also has a video entertainment platform, Youku, but Gong has made it a point to call the parent company a rival. That was also the time when Gong compared iQiyi to Disney, though he added that his company wasn’t planning to build theme parks. Instead, iQiyi has invested in AI, gaming, e-sports, online wallets – and brick-and-mortar movie theaters, among other investments.
Disney, though? Really?
Currently controlled by China’s top search engine Baidu (Nasdaq: BIDU), iQiyi lifted off in a $2.25 billion IPO in March 2018 before the relations between Washington and Beijing soured and left markets wary of Asian listings. Looking at the largest Chinese IPOs in New York this year – the latest of them being real estate platform KE Holdings Inc. (NYSE: BEKE), which raised $2.12 billion and soared 87% on debut day – you can’t help but think iQiyi got lucky in 2018. Its stock traded near $22 per share this week – that’s compared to its $18 per share issue price. Today, IQ traded at $18.50 per share, weighed on by news of the probe.
IQiyi had previously denied the fraud allegations. However, in the earnings report for the second quarter, released Thursday after the markets closed, the streaming giant stated that in addition to the investigation by the SEC's Division of Enforcement, “Professional advisers have been examining the Company's books and records and undertaking testing procedures that, in their judgment, are necessary and appropriate to evaluating the key allegations in the Wolfpack Report, including accounting policy analysis, data analytics on whether the Company manufactured orders and inflated revenues and/or expenses.”
IQiyi also said it was cooperating with the probe.
Other Chinese companies hit by short-seller allegations or investigating fraud this year were TAL Education Group (NYSE: TAL) and GSX Techedu Inc. (NYSE: GSX). However, the most notorious of them all was Luckin Coffee (OTC: LKNCY), which was forced to delist from Nasdaq just a year after IPO after confirming inflating sales by over $2 billion.
When the short-seller claims against iQiyi failed to significantly impact the company in April, TechNode’s Wei Sheng wrote, “Iqiyi is not Luckin. Three-year-old Luckin is a failed attempt to blitz-scale a coffee chain that never proved its model. Iqiyi, founded 10 years ago, is one of the few survivors of the ruthless competition in China’s video-streaming market and it has a mature business model. The company has its problems, but the short report seems to have missed its mark.”
Hedge fund Tiger Global went ahead and exited iQiyi on Friday, but some analysts remain optimistic. Bernstein’s David Dai told CNBC that the probe offered iQiyi a chance to “clear doubts.”