Netflix Goes to China With Help From iQiyi

In this segment from MarketFoolery, host Chris Hill and Million Dollar Portfolio's Matt Argersinger consider Netflix's (NFLX -8.38%) deal with Baidu's (BIDU -0.44%) video streaming service iQiyi. Plenty of multinationals have run into major trouble trying to access China's vast markets, so its choice to make a licensing deal with a local platform looks like a smart play -- possibly the only play at this point.

Chris Hill: I know we talked about Netflix yesterday raising $1 billion in financing, but they're back in the news today. Netflix has struck a deal in China with iQiyi, which is one of the leading video-streaming platforms, it is a subsidiary of Baidu. We see the stock up 2%. This is going to be interesting, to see where this deal goes from here. Netflix has been trying for a long time to get into China. They're not the first U.S. company that's tried to do business in China.

Matt Argersinger: And it won't be the last.

Hill: It won't be the last. And they've decided to go this route, which I think is a smart deal. It's a licensing deal, it's one of the biggest platforms. As of late last year, iQiyi had 480 million monthly active users. In terms of getting Netflix original content in front of a very large and new audience...we don't know what the terms of the deal are, but just in terms of the audience, it seems like a win.

Argersinger: I agree. I think it's a win for both. Netflix, as you hinted at, it's been an enormous challenge to get into China directly. In fact, I think in October, they gave up. Reed Hastings, on the conference call, said, "We've run into a buzzsaw trying to get into China, so we're going to pursue some deals, some joint ventures and licensing deals," and this is the first major one. I like the deal because for iQiyi, they were called the YouTube of China for a long time, and they have a lot of free content, but they did shift to a subscription model last year or the year before, and they've slowly grown that business. But what they've struggled with is content, they've had to pay a lot for content.

With the deal with Netflix, you bring in a lot of curated content -- because I'm sure the Chinese government is going to have a lot to say about what kind of content Netflix is able to get into iQiyi's platform, but at least for iQiyi, it gives them great content. For Netflix, it gets them that foothold in China. If Chinese consumers like a lot of the Netflix content, it opens the path for them to get more and more content in. I think, eventually, you could see Netflix saying, "If this is working, maybe we'll do a joint venture with iQiyi, where we're supplying a lot of the content, they're handling all the distribution, and we're splitting the subscription revenue 50-50 or something like that." It's a bit of a long game that Netflix is playing, but if you are shareholder, I think it's a positive move. It's the foothold you've been looking for. I don't think it will be that accretive to revenue. I think Netflix has said these licensing deals aren't going to be a big uptick to revenue. But, down the road, lead to big things.

Hill: I want to hit on a couple points there. One, before I forget, you had mentioned the content in China, and what's going to be allowed and what's not. I think it certainly works in Netflix's favor that they have a pretty large portfolio of original content. This is not four or five years ago, where they basically had a couple of shows, and that's it. They have a lot of original content. And we'll find out in the coming weeks and months what exactly is the content that's going to be available in China, because it's not going to be everything. We know there are movies that are made in the U.S. that are altered to be shown in China, they are edited in some ways. We also know there are directors in Hollywood -- Quentin Tarantino is one who comes to mind -- I don't think any of his movies have ever been shown in China, because he said, "I'm not changing my movies, I'm not going to edit them for the Chinese government or any government." You're right, it's not going to be accretive to revenue. I think it does probably help them down the line when they are making a pitch to content creators. Robert Roy, who's the VP of content acquisition, he's the guy at Netflix that's in charge of going out to content creators. We've talked before how, if you're a content creator right now, it's your market. It's a seller's market. You have Amazon, you have Hulu --

Argersinger: You've got bidders.

Hill: You have bidders. You have YouTube, and obviously Netflix. I think if you're Robert Roy at Netflix, now, you get to go to content creators and say, "Oh, and by the way, we can get you in front of an audience in China in a way that some of these others can't."

Argersinger: Right. And it's an audience that's about 1.4 billion people large. Very compelling. I think, yeah, you're exactly right. They now have the access. Now, we can make movies that we're 95% sure will get into China, as opposed to saying, "What do we have that we can alter or edit?" It's a great point.

Hill: One of the things we were talking about earlier this morning, you read these stories about this deal, and you start to gain some insight into just how competitive the video-streaming industry is in China. iQiyi is a Baidu subsidiary. Alibaba has their subsidiary. Tencent has their subsidiary. Just like we have the clash of the titans here in the U.S., that's absolutely playing out in China.

Argersinger: It is. China is an interesting case, too, because unlike the U.S., there really wasn't this linear TV market that we've had in the U.S. for decades. In China, they were so quick to move directly to streaming on my computer or my mobile phone on my tablet. It's amazing to see, unlike us, where we had the cable networks and things like that, no, these are the players in China, and they've already grabbed significant turf. It's going to be a clash of the titans. I think iQiyi, Netflix deal, it's a bit of a leg up for them today.