iQIYI Tumbles 12% On SEC Probe Over Fraud Allegations

iQIYI Inc. shares are dropping 12% in pre-market trading after the Chinese online entertainment service disclosed that the US Securities and Exchange Commission (SEC) has opened an investigation into the company.

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The stock is declining to $19.16 in Friday’s pre-market trading. Nasdaq-listed iQIYI (IQ) said that the SEC is “seeking the production of certain financial and operating records dating from January 1, 2018, as well as documents related to certain acquisitions and investments”.

“The company is cooperating with the SEC,” IQ said in a statment. “We cannot predict the timing, outcome, or consequences of the SEC investigation.”

The probe was prompted by a report issued by short-seller firm Wolfpack Research in April this year, the company said. The report alleges that “IQ was committing fraud well before its IPO in 2018 and has continued to do so ever since.” It estimates that IQ inflated its 2019 revenue by approximately RMB 8-13 billion, or 27%-44%, by overstating its user numbers by approximately 42%-60%.

According to the report, IQ inflates its expenses, the prices it pays for content, other assets, and acquisitions to “burn off fake cash to hide the fraud from its auditor and investors.”

“Shortly after the publication of the Wolfpack Report, the company engaged professional advisers to conduct an internal review into certain of the key allegations in the Wolfpack Report and to report their findings to the company’s Audit Committee,” IQ added. “These professional advisers have been examining the company’s books and records and undertaking testing procedures, including accounting policy analysis, data analytics on whether the company manufactured orders and inflated revenues and/or expenses.”

IQ said that the internal review is still ongoing adding that it can’t predict the timing for completion, outcome, or consequences for now.

Earlier this month, Oppenheimer analyst Bo Pei reiterated a Hold rating on the stock, saying that in light of viewership data and declining subscriber trend, investors should wait for catalysts. (See IQ stock analysis on TipRanks)

“While viewership has picked up since 3Q from 2Q’s trough, due to a later school summer break and a less compelling content slate, QTD total viewership is down 32% y/y, with VIP-exclusive content viewership -12% y/y,” Pei wrote in a note to investors. “In addition, macro environment remains challenging for most offline businesses in China and continues to weigh on brand advertising budgets.”

So far IQ, which is majority owned by Baidu Inc (BIDU), has maintained a cautiously optimistic outlook from the Street with a Moderate Buy analyst consensus based on 2 recent Buy ratings versus 4 Hold ratings.

The $21.30 average analyst price target indicates 1.8% downside potential, with the stock up 2.7% year-to-date.