Key Takeaways:

• A Reuters report says search engine giant Baidu is considering selling the recently profitable iQiyi platform with a target price of $7 billion
• iQiyi denied the report. But it could make sense for Baidu to divest from video streaming to sharpen its focus on cloud services, AI and self-driving products

By Fai Pui

Just as the video platform Beijing iQiyi Science & Technology Co. Ltd. (NASDAQ:IQ) managed to report its first profit, rumors are swirling that the online entertainment service faces a dramatic plot twist: a break-up with its majority shareholder Baidu Inc. (NASDAQ:BIDU).

A news report by Reuters last Wednesday said Baidu had reached out to Bank of America to explore a sale of its stake in iQiyi, with potential interested buyers including the telecom operator China Mobile (0941.HK) and the Hong Kong private equity firm PAG.

Online streaming service iQiyi swiftly denied the report as pure rumor. But Baidu’s silence on the potential sale has only intensified debate about whether its involvement with the Netflix-like video business is entering a final chapter.

Baidu currently owns 53% of iQiyi’s shares but holds more than 90% of the voting rights. The reported divestment plan would value the video-streaming platform at $7 billion with a target price of $8.13 per share, 78% higher than the $4.56 per share on the day the report was published.

The day after the story came out, iQiyi’s stock price fell 9% at one point and closed with a drop of 4.4% at $4.36. Baidu’s stock tumbled by 5.1% and closed at $137.38 per share.

Investors may have their doubts, but Baidu could have good reasons for wanting to part company with iQiyi. In recent years, Baidu has been re-focusing its operations and the iQiyi entertainment business is not a core element. In addition, iQiyi is still under heavy business pressure despite its improved first-quarter earnings performance. Third, iQiyi’s new-found profitability could help Baidu attract more buyers and secure a good deal.

Focusing on AI

Baidu hopes to focus more attention on its AI business, according to the Reuters report. Facing challenges from a government crackdown on the Internet sector, Baidu started to lay off people last year especially employees in its livestreaming and gaming operations.

Meanwhile, the company’s bigger investments in AI, cloud services and autonomous driving are reaping rewards, fueling a 35% increase in Baidu’s non-online marketing revenue in the first quarter to 5.7 billion yuan ($850 million).

The driverless car business is gathering speed, revved up by government policy support. Baidu’s intelligent driving system Apollo is making headway. In the first quarter the company reached a deal to provide automotive firm BYD (1211.HK; 002594.SZ) with high-precision mapping, assisted driving and autonomous parking services.

Baidu’s platform for autonomous driving services covers 10 cities in China and the company has received 196,000 orders so far for driverless cars. In April, it obtained a license to offer its robotaxi service in a district in Beijing.

Like the U.S. streaming giant that it is often likened to, “China’s Netflix” has been grappling with stiffer competition, with the growth of rivals such as Youku, indirectly owned by Alibaba (NYSE:BABA) and Tencent Video as well as Mango TV affiliated to Tencent (0700.HK).

And iQiyi’s profit turnaround was largely achieved by cost-cutting. iQiyi has shed 20% of its staff while trimming its portfolio of variety shows and cutting promotion costs. Its revenue fell 9% in the first quarter to 7.3 billion yuan, but it managed to land in the black because of a 16% cut in costs.

Under intense pressure

The company has always seen high-quality content as the key to retaining subscribers, but repeated waves of the Covid pandemic in the past two years have hampered production of TV and variety shows. It is proving increasingly difficult for iQiyi to cut costs while maintaining content quality.

The company is not in peak financial health either. The first-quarter financial statement released in May shows a net outflow of 1.17 billion yuan in operational cash and a combined liability of 36.7 billion yuan by the end of March, bringing its assets-to-liabilities ratio to 84%.

In March, iQiyi signed a new agreement with long-term investors including Baidu to secure $285 million in financing. As long as Baidu keeps hold of iQiyi, it may have to keep providing cash infusions.

The final factor is timing, as iQiyi’s first-quarter profit could help achieve a higher sale price for the business. The company’s earnings-per-share (EPS) was $0.03 in the first quarter and is projected to reach $0.12 for the whole year. If a buyer was willing to pay $7 billion, the company’s price-to-earnings (P/E) ratio would reach 67.7 times, representing a great deal for Baidu.

China’s ebullient entertainment industry has been reeling from several heavy blows in recent years, as the government clamped down on what it regarded as vulgar or low-brow content. Celebrity culture took a major hit, with bans on certain idol competitions and shows about stars’ family lives. 

Many online fan communities and chat rooms have been dissolved.

All these changes have hurt film and television businesses, causing some investors to conclude that iQiyi could be a liability for Baidu, and stoking the current speculation about a sale.

If Baidu can offload its iQiyi stake at a high price, the sale might help assuage any market doubts about the internet giant’s own future, enabling it to concentrate on the three pillars of cloud services, AI and automotive technology to drive its long-term growth.