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Don't Expect Netflix to Enter China Anytime Soon

By Adam Levy – Oct 15, 2016 at 2:04PM

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New regulations make it unlikely that Netflix will enter China in the foreseeable future.

Image source: Netflix.

In January, Netflix (NFLX 0.22%) announced its global expansion to 130 additional countries, bringing the streaming service to nearly every market in the world. There is, however, one glaring omission: China. The Chinese government censors much of the media its citizens consume, so media companies like Netflix must work closely with the government before entering the market.

At The New Yorker TechFest earlier this month, Netflix CEO Reed Hastings told the audience that the likelihood of it entering China "doesn't look good." He cites the recent shutdown of the Disney (DIS 2.46%) and Apple (AAPL 1.19%) movie services as a sign that Chinese regulators are cracking down on foreign media companies. Instead, he's focused on the rest of the world right now.

The recent shutdowns

Both Disney and Apple were forced to shut down their online services earlier this year after new regulations went into effect limiting online delivery of foreign content.

Disney had to ditch its DisneyLife streaming service, which offers access to its catalog of Disney films, television, music, and books. The service was online for just five months before Chinese regulators shut it down -- customers who bought a yearlong subscription have been reimbursed.

Apple, meanwhile, was forced to shut down its iTunes Movies and iBooks stores to comply with the new regulations. The digital media stores were also short-lived, opening just six months prior to the new regulations taking effect.

Considering that Netflix's global strategy relies on its growing amount of original content for which it owns global rights, an entry into China with its current regulations isn't going to work. Netflix would have to develop a whole new service with local content, and even then, it's no guarantee it will get government approval.

The importance of China

Perhaps the most significant part of China's shutdowns of both Apple and Disney's online services is that both companies have a significant presence in the country already.

Disney recently opened a theme park in Shanghai, spending $5.5 billion on the park's development. The company estimates that there are 330 million people within a three-hour radius who also have the financial means to come to the park. It's a big bet on the growing Chinese middle class.

What's more, Disney movies have proven popular in China. Zootopia, Captain America: Civil War, and The Jungle Book are among the top 10 highest-grossing films for the year in China. The opening of Shanghai Disneyland could help reinforce Disney's success at the box office.

Apple, meanwhile, generated 25% of its revenue from Greater China last year. It became the company's second-largest market in sales last year, but it may cede that position back to Europe this year.

The value in China is huge. Box office spending in the country could eclipse the U.S. by next year. What's more, the average person in China is spending more and more on entertainment every year.

Indeed, missing out on China is a big blow for Netflix.

Focusing on what it can control

"We're focused on the rest of the world," Hastings told the audience at the TechFest. Netflix is investing heavily in content for international markets including both global licenses and local content. Additionally, it's producing content in local languages for several key markets and, next year, the company plans to spend even more than its 2016 budget of $6 billion.

Hastings' focus is on driving subscriber growth. While most analysts understand the strategy, Deutsche Bank analyst Bryan Kraft recently called into question the consensus estimate for Netflix's cash-flow expectations in light of its aggressive investments in international content rights. He doesn't see Netflix producing positive cash flow until 2020, whereas most analysts are projecting positive cash flow in 2020.

As long as subscribers continue to pour in from international markets, Netflix is in a strong position to prove the value of its product and eventually slow content investment and raise prices. Being locked out of the valuable Chinese market will make the task more difficult, but there's still plenty of potential throughout the rest of the world.

Adam Levy owns shares of Apple. The Motley Fool owns shares of and recommends Apple, Netflix, and Walt Disney. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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