Executive Summary / Key Takeaways

• iQIYI is executing a radical strategic pivot toward microdramas—short-form vertical content with production costs under RMB 2 million per title—that management believes will create a market larger than China's entire box office, offering a structural solution to the company's chronic advertising revenue volatility and high long-form content costs.

• Artificial intelligence integration has evolved from a cost-saving tool to a genuine revenue driver, delivering 20% higher click-through rates on video ads and 10x efficiency gains in digital asset generation, potentially transforming the unit economics of content production at a time when competitors are still treating AI as experimental.

• The overseas business has achieved eight consecutive quarters of profitable growth, with membership revenue expanding 40% annually and markets like Brazil and Indonesia more than doubling, providing iQIYI with its first credible diversification away from China's saturated and regulatorily complex domestic market.

• Despite these promising vectors, iQIYI trades at just 0.52x sales with a negative 1.82% operating margin, reflecting investor skepticism about execution history—the company has repeatedly cited "lighter content slates" for revenue shortfalls—and the structural challenge of competing against Tencent Video's ecosystem moat and Bilibili's youth demographic dominance.

• The investment thesis hinges on whether iQIYI can convert its 20,000-title microdrama library into sustainable advertising and e-commerce revenue while maintaining its long-form content leadership, with the next 12-18 months serving as a critical proving ground for management's claim that AI will bring "dramatic change" to the industry within five years.

Setting the Scene: The Streaming Wars' Forgotten Contender

iQIYI, incorporated in 2009 as Qiyi.com and renamed in November 2017, operates as China's second-largest long-form video streaming platform, yet it has long been perceived as the industry's perennial underdog. The company generates revenue through four primary segments: membership subscriptions (RMB 4.2 billion in Q3 2025), online advertising (RMB 1.2 billion), content distribution (RMB 644.5 million), and other revenues including IP licensing and offline experiences. This business model places iQIYI at the center of China's oligopolistic streaming market, where it competes against Tencent Video (TCEHY:TCEHY)'s WeChat-integrated ecosystem, Alibaba (BABA:BABA)'s Youku with its e-commerce synergies, and Bilibili (BILI:BILI)'s Gen Z-dominated community.

The industry structure reveals iQIYI's core challenge. While Tencent Video commands approximately 110 million household penetration and Bilibili captures the lucrative 15-25 demographic with its bullet-comment culture, iQIYI has struggled to differentiate beyond being a premium content aggregator. The company's Baidu (BIDU:BIDU)-backed heritage provides AI capabilities but lacks the social distribution muscle of Tencent or the commercial transaction data of Alibaba. This positioning has historically forced iQIYI into a costly content arms race, with original productions like "The Shadow Edge" grossing RMB 1.2 billion but requiring massive upfront investment and bearing hit-driven volatility.

Three seismic shifts are now reshaping this landscape. First, user behavior is fragmenting—viewers increasingly consume content in sub-20-minute sessions, driving the microdrama explosion. Second, AI is moving from experimental to essential, with generative tools promising to cut production costs by over 50% while personalizing content at scale. Third, Chinese content is gaining global currency, with C-drama searches reaching five-year highs and surpassing Korean dramas worldwide. iQIYI's strategic response to these trends—doubling down on microdramas, embedding AI across its workflow, and accelerating overseas expansion—represents either a brilliant pivot or a desperate gamble, depending on one's view of management's execution credibility.

Technology, Products, and Strategic Differentiation: The Microdrama-AI Flywheel

iQIYI's product strategy has bifurcated into two distinct ecosystems: the main iQIYI app for subscription-based long-form and premium microdramas, and the iQIYI Lite app for free, ad-supported microdramas. This separation matters because it allows the company to capture both ends of the user spectrum—premium subscribers willing to pay for quality and price-sensitive users who generate advertising and e-commerce revenue. By Q3 2025, this strategy had expanded the microdrama library to over 20,000 titles, with more than half available for free, creating an inventory base that management believes can support a self-sustaining advertising business.

The economics of microdramas fundamentally alter iQIYI's cost structure. While a traditional long-form drama can cost tens of millions of RMB, microdramas average under RMB 1 million per title, with top-tier productions under RMB 2 million. Yet engagement metrics are staggering: daily viewing time and unique visitors for microdramas increased over 300% and 110% respectively from December 2024 to April 2025. In Q3 2025, microdramas ranked second only to long-form dramas across core metrics overseas, while attracting brand sponsorships and generating 114% sequential growth in overseas membership revenue. This creates a powerful flywheel—lower content costs, higher user engagement, and diversified monetization through both subscriptions and advertising.

AI integration amplifies these advantages across four dimensions. Operationally, AI automates marketing material generation and overseas content translation, cutting costs and accelerating speed-to-market. For monetization, AI-powered video ads achieve 20% higher click-through rates and optimize placement algorithms, directly boosting advertising ROI. In content production, AI supports screenplay evaluation, character design, and microanimation creation, with the Peter Pau iQIYI AI Center pioneering next-generation talent development. For user experience, features like iJump (allowing swipe-based navigation through long-form content) and the Touhou AI personal assistant redefine engagement, making even traditional dramas feel like microdrama experiences.

The strategic implications are profound. While competitors treat AI as a feature—Tencent uses it for recommendation optimization, Bilibili for community management—iQIYI is industrializing AI across the entire content lifecycle. This creates potential for structural cost advantages: AI-powered production on "The Great Nobody two" boosted digital asset generation efficiency over 10-fold, cutting both costs and production time. If iQIYI can maintain this edge, it could escape the content cost inflation that has plagued the industry, transforming its gross margin profile from the current 22.3% toward the 36-41% levels seen at Bilibili and Alibaba.

Financial Performance & Segment Dynamics: A Tale of Two Businesses

iQIYI's financial results reveal a company in transition, with legacy segments showing cyclical weakness while new growth vectors accelerate. Membership services, the core revenue engine at RMB 4.2 billion in Q3 2025, demonstrates the hit-driven nature of the business—revenue declined 9% annually in Q2 due to a "lighter content slate" but rebounded 3% sequentially in Q3 on the strength of blockbusters like "The Thriving Land." This volatility underscores the strategic rationale for microdramas: a 20,000-title library provides scheduling flexibility and reduces reliance on individual hits, potentially smoothing quarterly fluctuations.

The advertising segment's performance exposes iQIYI's macro sensitivity. At RMB 1.2 billion in Q3 2025, revenue decreased 2% sequentially after a major campaign boosted Q2, while brand advertising showed double-digit annual growth driven by premium variety shows. However, management repeatedly cites "macro pressures" and "macro headwinds" as advertisers adjust strategies. This creates a critical vulnerability: iQIYI's advertising revenue is more cyclically exposed than Tencent's WeChat-integrated ads or Youku's e-commerce-linked spending. The company's response—expanding microdrama ad inventory and using AI to boost ROI by over 20%—shows promise, but the segment's 13% annual decline in Q2 reveals the challenge of competing for shrinking ad budgets.

Content distribution offers a bright spot, with revenue surging 48% sequentially to RMB 644.5 million in Q3 2025, driven by strong performance of original theatrical movies. This segment's volatility (down 37% annually in Q2, up 55% sequentially in Q1) reflects the timing of major releases, but the underlying trend suggests iQIYI's original productions are gaining external licensing value. The success of "The Shadow Edge" grossing RMB 1.2 billion validates the company's theatrical strategy, creating a new revenue stream beyond streaming.

The balance sheet transformation provides essential context for evaluating these segments. iQIYI has aggressively deleveraged, reducing convertible bond principal from RMB 2.9 billion in Q1 2023 to RMB 1.17 billion by Q1 2025, with net interest expense falling over 30% year-over-year.

The company has maintained 12 consecutive quarters of positive operating cash flow, totaling RMB 339 million in Q1 2025. CFO Jun Wang's assertion that "the capital structure now is pretty healthy enough to support our daily operations and also the long-term development and growth" is credible—the RMB 4.9 billion cash position provides runway for content investments.

However, profitability remains elusive. The -1.82% operating margin and -2.88% return on equity lag all major competitors, reflecting iQIYI's structural cost disadvantage in long-form content. The microdrama strategy directly addresses this: if iQIYI can shift even 30% of content spending to microdramas at one-tenth the cost, while maintaining engagement, the margin expansion potential is substantial. But execution risk is high—the company has repeatedly missed content slate timing, and the advertising market remains fragile.

Outlook, Management Guidance, and Execution Risk

Management's 2025 outlook centers on three pillars: premium long-form content quality, microdrama scaling, and overseas expansion. CEO Lu Gong frames this as "rapid transformation driven by technological innovation and evolving business models," with AI as the catalyst that will bring "dramatic change to our industry and the video content creation industry" within one to five years. This timeline is aggressive but aligns with observable progress: AI already delivers 20% CTR improvements and 10x production efficiency gains.

The content strategy aims to increase both quality and quantity of premium dramas while reducing episode counts for tighter narratives. This matters because it addresses the "lighter content slate" problem that caused Q2's 9% membership revenue decline. By planning more high-quality short dramas (5-20 minutes) alongside traditional series, iQIYI seeks to improve scheduling flexibility and reduce reliance on individual titles. Management explicitly states this approach will "reduce reliance on individual titles and effectively mitigate risk"—a direct admission that the current hit-driven model is unsustainable.

Microdramas are positioned as the primary growth engine. Management believes the 2024 microdrama market already exceeded China's box office and will surpass it again in 2025. The strategy of using the main app for paid microdramas and iQIYI Lite for free, ad-supported content creates a dual monetization path. By Q3 2025, microdramas ranked second in daily time spent and first in daily unique visitors, with overseas membership revenue from the category growing 114% sequentially. The key execution milestone will be consistent generation of RMB 1 million+ weekly revenue per title—achieved by some originals but not yet systemically.

Overseas expansion targets rapid revenue growth while maintaining profitability. The business has been profitable for "the past couple of years," according to the CFO, with membership revenue growing 40% annually in Q3 2025. The establishment of four operating regions (Southeast Asia, North America, Japan/Korea, Middle East/North Africa) and focus on local productions (Thai, Malaysian, Indonesian dramas) demonstrates a mature approach. The Thai-dubbed "Coroner's Diary" setting platform records and "King Jaro" topping Google and Twitter rankings proves local content can travel. The risk is that iQIYI is competing with Netflix (NFLX:NFLX) and Disney (DIS:DIS)+ in these markets, which have vastly larger content budgets.

AI investment represents both opportunity and cost pressure. Management is "investing heavily in AIGC and AI technology applications," with initiatives like the Google/ByteDance short film competition and Peter Pau AI Center designed to "discover and nurture AIGC creative talent." This spending pressures near-term margins but could create durable advantages if iQIYI's intelligent production system becomes an industry standard opened to partners.

Risks and Asymmetries: Where the Thesis Can Break

The most material risk is execution consistency. iQIYI's history of "lighter content slate" explanations for revenue shortfalls reveals a fundamental operational challenge in content planning and production. If the company cannot reliably deliver a steady stream of compelling content, even the best microdrama and AI strategies will fail to gain traction. This risk is amplified by the competitive intensity: Tencent Video's WeChat integration provides lower customer acquisition costs, while Bilibili's community-driven UGC model requires less capital-intensive production.

Advertising market cyclicality poses a structural vulnerability. Unlike Tencent or Alibaba, iQIYI lacks a diversified revenue base to cushion macro downturns. The 13% annual decline in Q2 2025 advertising revenue, attributed to advertisers "adjusting their strategies in response to macro pressures," demonstrates this exposure. While AI-powered optimization can improve ROI, it cannot create budgets that don't exist. A prolonged Chinese economic slowdown could compress advertising revenue by 20-30%, overwhelming microdrama gains.

Content cost inflation remains a persistent threat. While microdramas offer cost advantages, iQIYI must still invest in premium long-form content to maintain its brand position and satisfy core subscribers. The company's theatrical release strategy, while validated by "The Shadow Edge's" RMB 1.2 billion gross, requires massive upfront investment with uncertain returns. If iQIYI cannot achieve the promised production efficiencies from AI, content costs could consume 80-85% of revenue, preventing any path to profitability.

Overseas expansion faces competitive and regulatory headwinds. While growth is impressive, the 40% annual membership increase comes off a small base. Competing with Netflix's $17 billion content budget and Disney's global IP library requires either massive investment or a niche strategy. The company's asset-light approach (iQIYI Labs, immersive centers) is prudent but may limit scale. Additionally, content regulations in markets like Indonesia and the Middle East could restrict C-drama distribution, while U.S.-China tensions might trigger service restrictions.

Regulatory risk in China is ever-present. New policies promoting "healthy development" of long-form video, while currently supportive, could evolve to limit foreign content, cap subscription prices, or impose additional content review requirements that delay releases. The concurrent review process for dramas, while shortening cycles now, could become a bottleneck if political sensitivities increase.

The key asymmetry lies in AI's transformative potential. If iQIYI's intelligent production system can truly reduce content costs by 50% while improving quality, the company could achieve Netflix-like margins (20% operating margin) on a fraction of the revenue, justifying a significant re-rating. Conversely, if AI tools prove incremental rather than revolutionary, iQIYI will remain trapped in the capital-intensive content arms race, with its 0.52x sales multiple reflecting a terminal value concern rather than a temporary discount.

Valuation Context: Pricing in Execution Risk

At $2.07 per share, iQIYI trades at a market capitalization of $1.99 billion and an enterprise value of $3.5 billion, reflecting a debt-adjusted valuation that accounts for its RMB 4.9 billion cash position. The company's 0.52x price-to-sales ratio stands at a dramatic discount to streaming peers: Bilibili trades at 2.55x sales, Alibaba at 2.64x, and even profit-challenged Bilibili commands a 2.09x enterprise value-to-revenue multiple. This valuation gap suggests the market views iQIYI as a structurally impaired business rather than a temporarily challenged growth story.

Profitability metrics explain the discount. iQIYI's -1.82% operating margin and -2.88% return on equity compare unfavorably to Bilibili's 4.61% operating margin and 5.35% ROE, and are a world away from Tencent's 32.95% operating margin and 19.83% ROE. The gross margin of 22.3% lags Bilibili's 36.4% and Alibaba's 41.2%, reflecting iQIYI's higher content cost burden. However, the company's 26.49x price-to-free-cash-flow ratio is actually more favorable than Bilibili's 18.84x, suggesting the market gives iQIYI some credit for its positive cash generation.

Balance sheet strength provides downside protection but also reveals constraints. The debt-to-equity ratio of 1.11 is higher than Bilibili's 0.65 and Tencent's 0.32, though the trend is improving rapidly. The current ratio of 0.44 indicates tight working capital management, typical for subscription businesses but leaving little cushion for operational missteps. Critically, the company has maintained 12 consecutive quarters of positive operating cash flow, providing evidence that the core business model is viable even if accounting profitability remains elusive.

Valuation must be framed around the transformation narrative. If iQIYI can achieve management's goal of making microdramas a revenue engine comparable to the Chinese box office (roughly RMB 50-60 billion annually), even a 10% market share would add RMB 5-6 billion in high-margin revenue, potentially doubling the company's revenue base. The 0.52x sales multiple would then appear severely mispriced. Conversely, if execution faltering continues and advertising revenue declines 10-15% annually, the company's RMB 4.9 billion cash could be depleted within 3-4 years, making the current valuation a fair reflection of terminal decline risk.

Conclusion: A Show-Me Story at a Show-Me Price

iQIYI stands at a critical juncture where its strategic pivot to microdramas, industrialized AI production, and profitable overseas expansion could fundamentally reshape its economic model. The company's 20,000-title microdrama library, 40% overseas membership growth, and AI-driven 20% advertising ROI improvements provide tangible evidence that management's transformation narrative is more than aspirational. Yet the stock's 0.52x sales multiple and negative operating margins reflect a market that has grown weary of execution missteps and structural competitive disadvantages.

The investment thesis ultimately hinges on whether iQIYI can convert operational improvements into sustainable profitability before its cash advantage erodes. Success requires three things: consistent content delivery that eliminates "lighter slate" excuses, microdrama monetization that scales beyond experimental revenue, and overseas expansion that maintains profitability while growing share. If the company delivers on these fronts, the valuation gap versus peers could close rapidly, offering 100-200% upside as margins expand and revenue diversifies.

Failure, however, would confirm the market's skepticism. Continued ad market share loss to Tencent and Alibaba, microdrama monetization that stalls at experimental levels, or overseas growth that requires unsustainable investment would validate the current discount and potentially lead to further multiple compression. For investors, the next four quarters will serve as the proving ground: either iQIYI's AI-microdrama-overseas flywheel achieves escape velocity, or the company remains a cautionary tale about the difficulty of competing against ecosystem giants in China's hyper-competitive streaming landscape.