Netflix Goes to China With Help From iQiyi

By Motley Fool Staff Markets Fool.com

In this segment fromMarketFoolery, host Chris Hill andMillion Dollar Portfolio's Matt Argersingerconsider Netflix's (NASDAQ: NFLX) deal with Baidu's (NASDAQ: BIDU) 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.

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A full transcript follows the video.

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This video was recorded on April 25, 2017.

Chris Hill:I know we talked about Netflix yesterday raising $1 billion in financing, but they'reback in the news today. Netflix has struck a dealin China withiQiyi,which is one of the leading video-streaming platforms,it is a subsidiary ofBaidu. 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:
Itwon't be the last. And they've decided to go this route, whichI think is a smart deal. It's a licensing deal, it'sone of the biggest platforms. As of late last year, iQiyi had 480 millionmonthly active users. In terms ofgetting Netflix original content in front of a very large and new audience...we don't know what the terms of the deal are, but justin 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 anenormous challenge to get into China directly. In fact,I think in October, they gave up. Reed Hastings, on the conference call, said, "We'verun into a buzzsaw trying to getinto China, so we're going to pursue some deals, some joint ventures andlicensing deals," andthis 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 havea lot of free content, but they did shift to a subscription model last year or the year before, and they'veslowly grown that business. Butwhat they've struggled with is content, they'vehad 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 sayabout 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 Chineseconsumers like a lot of the Netflix content, itopens 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'rehandling all the distribution, and we'resplitting the subscription revenue 50-50 orsomething like that." It'sa bit of a long game that Netflix is playing, butif 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 theselicensing 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 hadmentioned the content in China, andwhat's going to be allowed and what's not. I think it certainly works in Netflix's favor that they have apretty large portfolio of original content. This is not four or five years ago, where theybasically had a couple of shows, and that's it. They have a lot oforiginal content. And we'llfind out in the coming weeks and monthswhat exactly is the content that's going to beavailable in China, becauseit'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 aredirectors 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'mnot changing my movies,I'm not going to edit themfor 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 linewhen they are making a pitch tocontent creators. Robert Roy, who'sthe VP of content acquisition, he's the guy atNetflix 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 haveHulu --

Argersinger:
You've got bidders.

Hill:
You have bidders. You haveYouTube, andobviously Netflix. I think if you're Robert Royat Netflix, now, you get to go to content creators and say, "Oh, andby 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. Andit's an audience that's about 1.4 billion people large. Very compelling. I think, yeah, you'reexactly right. They now have theaccess. 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 youstart to gain some insight into just how competitive the video-streamingindustry is in China. iQiyi is aBaidu subsidiary.Alibabahas their subsidiary.Tencenthas theirsubsidiary. Just like we havethe clash of the titans here in the U.S., that'sabsolutely playing out in China.

Argersinger:
It is. China is aninteresting case, too, because unlike the U.S., therereally 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 mycomputer or my mobile phone on my tablet. It'samazing to see, unlike us,where we hadthe cable networks and things like that, no, these are the players in China, and they've already grabbed significant turf. It'sgoing to be a clash of the titans. I think iQiyi, Netflix deal,it's a bit of a leg up for them today.

Chris Hill owns shares of Amazon. Matthew Argersinger owns shares of Amazon, Baidu, and Netflix. Matthew Argersinger has the following options: short December 2017 $800 puts on Amazon. The Motley Fool owns shares of and recommends Amazon, Baidu, and Netflix. The Motley Fool has a disclosure policy.