Why Netflix Hasn’t Taken Off in China

Last year, Netflix (NFLX -9.09%) announced that it was going to work on getting into just about every international market in the world. But while it's seeing success in numerous countries, the streaming company is hitting some significant speed bumps in China.

In this segment from Industry Focus, market analysts explain why that is and why that'll likely continue to be the case for the foreseeable future. Click play to find out why China's laws are keeping Netflix from really taking off, just how huge the Chinese streaming market is, how Netflix might be able to make a more solid name for themselves in that country, and more.

A full transcript follows the video.

This video was recorded on Oct. 13, 2017.

Dylan Lewis: One market where I think we have these huge expectations as investors and consumers for a lot of multinationals, where Netflix is frankly not going to see massive growth, is China. And that's because, they've tried to crack this nut for a while, and they're kind of there now, but not really in the same way that they're in all the other countries. Right, Danny?

Danny Vena: You're exactly right, Dylan. A little bit of background on China to help set this up: China has very strict rules regarding imported material. And that extends to content, as well. And when Netflix was trying to break into the Chinese market, one of the things they were up against was a government regulation that said no service could have more than 30% of foreign content. So, that's going to be all content in the United States and every other country. So, there was a very small area for them to break into. So, what Netflix did was partner with Baidu (BIDU -0.56%). Baidu is the online search engine of choice in China. Baidu has a service called iQiyi. iQiyi is widely considered to be the Netflix of China. So, they partnered with iQiyi, with Baidu, and you can see some Netflix originals on iQiyi's streaming service in China.

Lewis: But, with the nature of that contract, and it being more of a licensing deal than them being able to pull in these recurring subscription revenue figures every quarter, every month, that's going to change the way they're able to make money. It caps what things might actually look like for Netflix in China, at least for the foreseeable future.

Vena: Right. It completely changes the dynamic of how they make money there. And you're right, they're not going to be able to get the recurring revenue stream from the subscriber base. What they'll do is, they'll negotiate with Baidu and iQiyi. I recently found out that sometimes it takes up to a year for content to be approved. Once it's submitted to the government, it has to be approved before it can go on the air, and sometimes those approvals can take more than a year.

Lewis: Yeah. So, don't expect anything too big out of China, at least for Netflix's results specifically. If you're interested in seeing what's going on with the streaming space in China, there are some recent developments with Baidu and iQiyi that might give us a little more insight into what's going on in that market.

Vena: One of the news stories that hit recently was, Baidu is considering an IPO for its streaming service iQiyi, valuing that company at somewhere between $8 [billion]-$10 billion. There's been some controversy around that before. Robin Li, who is the CEO of Baidu, last year tried to spin that off and actually buy it and take it private. There was a little bit of a shareholder uproar over that. They abandoned that plan. So now, they're trying to spin it out as a public company. What they were planning on doing was maintaining more than 50% control of it and spinning off the remainder. But, we do have some research out there that gives us a little insight into the market in China. Streaming video is extremely popular in China, with an estimated 144 million subscribers that will tune in this year, and that's an 80% increase over last year.

Lewis: I think, for context, think about that, was it 50 million subscribers that Netflix has in the United States right now. That's a massively larger market at the moment.

Vena: And iQiyi, according to some estimates from JPMorgan that we got via eMarketer, they forecast that this year, iQiyi will have 99 million subscribers -- effectively twice what Netflix has in the domestic market, and nearly what we have worldwide.

Lewis: Which is absolutely crazy. And it doesn't seem like Netflix will get any meaningful exposure to this market, but with the possibility of iQiyi being spun out and run as its own public company at some point, we might get a little more flavor for what those types of deals look like for Netflix, and what the appetite for streaming content looks like in China going forward. Because, eventually, I have to think Netflix is going to want a slightly larger piece of that pie, and try to figure out how to make that happen.

Vena: I know they've been working on it, and Reed Hastings and the company has said in the shareholder letter that they just don't have a way into the country, at least not meaningfully at this point. They have the licensing deal with the iQiyi service, they may be able to license some content with some other providers there.