IQIYI: The Netflix Of China? Good Luckin.

Our research shows us that iQIYI, Inc. (“IQ”) was committing fraud well before its IPO in 2018 and has continued to do so ever since. Like so many other China-based companies who IPO with inflated numbers, IQ is unable to legitimately grow their business enough to true up their financial statements. We estimate IQ inflated its 2019 revenue by approximately RMB 8-13 billion, or 27%-44%.

IQ does this by overstating its user numbers by approximately 42%-60%. Then, IQ inflates its expenses, the prices it pays for content, other assets, and acquisitions in order to burn off fake cash to hide the fraud from its auditor and investors.

We conducted in-person surveys of 1,563 people within IQ’s target demographic in China during October and November 2019 and found that approximately 31.9% of IQ users have access to its VIP-only content through their memberships with IQ’s partners such as JD.com or Xiaomi TV. IQ accounts for dual memberships on a gross basis, meaning it records the full amount of revenue and records its partners’ share as expenses. This allows IQ to inflate its revenues and burn off fake cash at the same time.

We also obtained Chinese credit reports for all of IQ’s VIEs and WFOEs since 2015. When compared to IQ’s prospectus, we found that the deferred revenues reported to the SEC were inflated by 261.7%, 165.5% and 86.2% in 2015, 2016 and 2017, respectively. Deferred revenue is a balance sheet account that arises when customers prepay for a service to be delivered in the future. Because IQ’s subscription customers prepay, most of its revenues are a function of deferred revenue. These pre-IPO overstatements inherently cause IQ’s post-IPO revenues to continue to be overstated.

Arguably one of the most egregious examples of accounting fraud IQ commits is the inflation of its barter transaction revenue. Barter sublicensing revenues are determined by IQ’s internal estimates of the value of the content it traded. In other words, IQ’s management can effectively assign any value they want to these transactions, providing an easy opportunity to inflate its revenues. Based on the highest-end estimated value per non-exclusive episode provided by a former IQ employee involved in content acquisition, IQ would have needed to barter the licenses for ~3.9x and ~3.2x the total number of TV series episodes produced by all Chinese production companies to legitimately reach its reported barter revenues in 2018 and 2019, respectively.