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Netflix takes China off its to-do list, for now

Netflix added service in 130 countries earlier this year, but efforts to launch a streaming service in China are now on hold. Photo: Bloomberg News

Netflix Inc. said Monday that its quest for global streaming supremacy will not include full service in China for now, keeping the world’s largest potential market off its global to-do list.

“The regulatory environment for foreign digital content services in China has become challenging,” Netflix said in its third-quarter letter to shareholders. “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.”

That little nugget of news got swallowed up by Netflix beating Wall Street’s expectations on earnings and subscriber growth, fueling a 20% surge its shares in after-hours trading Monday. However, it speaks to a larger truth: China’s censorship and other regulatory constraints make it one of the toughest markets for U.S. internet companies. Just last month, car-hailing app developer Uber Technologies Inc. decided to sell its Chinese operations to Didi Chuxing, marking the end of its costly and unprofitable efforts to establish a foothold there.

Netflix will follow a similar path, finding local entities to offer its programming. Fortunately for the company, previous problems with tech companies in China had already led to investors assuming failure for the direct route.

“We see entry into China as highly uncertain given the level of governmental restrictions and the high level of competition from large players,” Bryan Kraft, an analyst at Deutsche Bank, wrote in a note last week, in which he initiated coverage of Netflix with a sell rating due to its high valuation.

On the company’s call with investors on Monday, none of the participating analysts asked any questions about China, and instead focused on other global markets. Netflix said it has launched in a total of 130 global markets in 2016, helping fuel additions of 3.2 million subscribers outside the U.S. in the quarter, well more than the 2 million international subscribers it expected to add.

That international growth comes with serious costs and challenges. Netflix forecasts that its loss in international will grow moderately to $75 million in the fourth quarter, as it continues to invest in more content across newer international markets. It also warned about a tough compare in international net additional subscribers in the first quarter of 2017, because of a membership surge tied to the launch in all its new markets.

With all the success and challenges of Netflix’s international push, investors can shrug off Netflix’s comments about China, perhaps in a sigh of relief. But Netflix’s efforts will hit an eventual wall on subscriber growth, and China could then represent its only growth option. While Netflix and its investors can forget about China for now, they should expect the question to rise again in the future.

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