Investors in Netflix, Inc. (NASDAQ:NFLX) shouldn’t feel too bad right now. Yes, Netflix just essentially gave up on its quest to conquer China, but it was hardly a sure bet to benefit NFLX anyway.
China has been a kind of Holy Grail for U.S. companies since the beginning of the century. As the world’s largest market, it offers vast opportunities for growth, the thinking goes.
The reality is not so simple.
Netflix said it has decided against trying to build a full-service business in the Middle Kingdom. Rather, it will make deals with local partners. Like others before it, NFLX stock baked in some hope of Chinese riches, but the company came up against a nearly impenetrable wall of regulatory and legal requirements.
As NFLX said in its third-quarter letter to shareholders:
“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.”
As much as the potential of the Chinese market was on some shareholders’ minds, the potential for upside — or downside — mattered little to them. The news had no impact on Netflix stock as it soared on a blowout earnings report last week.
No one was betting on a successful foray into the giant market and that’s just as well. Yes, absolutely, China is a massive market that can do wonders for a company’s revenue growth.
But as so many other companies have found, it’s also kind of a headache.
China Would Be a Headache for China
About 10 years ago Yum! Brands, Inc. (NYSE:YUM) was touted as great play on China. Even better, it had yet to take off. And, indeed, China turned into a huge driver of revenue thanks to the popularity of KFC and Pizza Hut. (Yum also operates the Taco Bell chain.)
Cut to today, though, and Yum! Brands is spinning off Yum China to shareholders. It will be a separate publicly traded company that delivers licensing fees to its former parent. That’s a nice, high-margin way to generate revenue, but it’s hardly the path to riches Yum envisioned a decade ago.
Food safety scandals that hurt KFC were the proximate cause for the move, but it goes beyond that. Yum had a good run, but it’s simply too much of a hassle to run a business profitably in China.
That goes double for internet companies, where censorship and strict regulations choke off much of what they want to do.
Uber Technologies Inc., which has spread like a venereal disease, pulled up stakes last month after selling its operation to a local company. Facebook Inc (NASDAQ:FB) is actually blocked in China, as is Instagram, which it owns. Perhaps most famously, Alphabet Inc’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google quit China almost seven years ago because of censorship on the part of Chinese authorities.
Non-internet companies have found more success, but China still represents a double-edged sword.
For example, shares in General Motors Company (NYSE:GM) and Ford Motor Company (NYSE:F) have found a headwind in fears about a slowdown in the Chinese economy. Even when GM was printing record results in China earlier this year, the stock received no benefit from it. It does, however, appear to discount anxiety about the economy in that nation.
Suffice to say that China is not a license to print money for U.S. companies. It’s a hard market to navigate.
NFLX stock holders were wise to take a skeptical view of the chances for success.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.