Netflix Will Never Dominate the Streaming Market in China. Here's Why

By Danny Vena Markets Fool.com

In early 2016, when Netflix, Inc. (NASDAQ: NFLX) announced its availability in most of the world, China was one of several countries conspicuously missing from the list. Supplying service to the world's most populous country had long been an ambition of the streaming giant and in the company's letter to shareholders in October 2016, Netflix laid out its go-slow approach to the country:

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The regulatory environment for foreign digital content services in China has become challenging. We now plan to license content to existing online service providers in China rather than operate our own service in China in the near term. We expect revenue from this licensing will be modest. We still have a long term desire to serve the Chinese people directly, and hope to launch our service in China eventually.

Has Netflix abandoned China?" Does it matter? Image source: Netflix, Inc.

Government crackdown

So what was the nature of the regulatory environment that was so challenging? You might have guessed mere censorship, but the answer is much more complicated. Chinese regulators had enacted rules that impinged on the way Netflix could do business in the country.

For instance, the regulators required that data from technology companies be stored on servers in China and imposed a 30% limit on the amount of foreign content allowed on online streaming sites. They also required that foreign businesses partner with a Chinese company and dictated that all streaming content be submitted to the government agency in advance for approval. These onerous regulations were likely a contributing factor in Netflix's decision. And The Wall Street Journal reported recently that China has issued new rules to formalize and expand the regulations.

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This isn't anything new

This situation isn't new. Apple's iBooks Store and iTunes Movies in China were reportedly shuttered bythe State Administration of Press, Publication, Radio, Film and Television (SARFT) in early 2016, just six months after launch, as part of a larger crackdown of online services operated by other countries. At the time, China was Apple's second-largest market, behind only the United States. The Walt Disney Company's DisneyLife, the company's video-streaming service, reportedly met a similar fate just five months after its debut, even after partnering with a Chinese company.

Netflix isn't the only U.S. company facing hurdles in China. Image source: Netflix, Inc.

Hometown favorites gain ground

Even if Netflix was able to navigate the murky regulatory and censorship-laden waters of China, hometown favorites are staking their claims in the online streaming market. Chinese search giant Baidu, Inc. (NASDAQ: BIDU) runs iQiyi, the leading video-streaming site in China. In its most recent quarter, the company spent approximately $370 million, or 14% of its total revenue, on content. The service currently boasts 480 million monthly active users, though only about 20 million are paying customers. The remainder use iQiyi's ad-supported site, which is similar to Hulu. In mid-2015, Baidu added a paywall and began charging for newer releases. Subscribers quadrupled over the following year,and since then, the company has been investing heavily in exclusive and self-produced content.

Netflix has the rest of the world

Netflix may be missing out on China's 1.3 billion potential viewers, but it's making the most of its opportunity in the rest of the world. Jefferies analyst John Janedis recently surveyed consumers in Germany and India and found that they prefer Netflix and competitor Amazon.com (NASDAQ: AMZN) Prime's content to locally owned video-streaming services. An additional key finding was that many consumers in both markets subscribed to both Netflix and Amazon Prime, dispelling any notion that consumers would feel the need to choose one over then other.

Netflix may never dominate the streaming market in China, but investors are still benefiting. The service is nearing 100 million members worldwide in just 10 years since Netflix launched streaming in 2007, and one year since its expansion to 190 countries. In its most recent quarter, global streaming revenue grew 41% over the prior-year quarter to $2.4 billion, and the company added 7 million new members. The company seems to be doing just fine without China. Have a little Netflix and chill.

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Danny Vena owns shares of AMZN, AAPL, BIDU, NFLX, and DIS. Danny Vena has the following options: long January 2018 $80 calls on DIS, short April 2017 $105 calls on DIS, long January 2018 $85 calls on AAPL, and short January 2018 $90 calls on AAPL. The Motley Fool owns shares of and recommends AMZN, AAPL, BIDU, NFLX, and DIS. The Motley Fool has the following options: long January 2018 $90 calls on AAPL and short January 2018 $95 calls on AAPL. The Motley Fool has a disclosure policy.