Netflix giving up on China, for now, as provider concentrates on long-term content strategy

Image: Netflix

Netflix is backing away from any near-term launch in China, and instead will continue licensing its content to existing providers in the country, CEO Reed Hastings announced in a quarterly earnings letter to shareholders (PDF) on Monday, one that also outlined a forecast-beating quarter for subscriber numbers and revenue.

“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,” he said.

The announcement wasn’t unexpected, as Netflix has been quietly studying the problem of getting into China’s SVOD market for several months without much apparent progress. The main issue lies in China’s rules about foreign media companies operating within its borders; such companies must partner with existing Chinese media organizations.

Reading into Hastings’ statement, it appears that Netflix didn’t see much return on any significant investment into China. “We expect revenue from this licensing will be modest,” he wrote, adding that “We still have a long term desire to serve the Chinese people directly, and hope to launch our service in China eventually.”

Backing away from what could be the biggest OTT market in Asia also signals that Netflix may be circling the wagons to protect its current subscriber base and revenues as competition continues to ramp up and subscriber numbers flatten out.

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The SVOD provider added 3.6 million new subscribers globally, including 400,000 subs in the U.S. and 3.2 million internationally. Over the past nine months, Netflix added 12 million new subscribers globally, “the same as in the first nine months of 2015,” Hastings noted.

Original content also took its toll on Netflix in the near term. The provider racked up a huge free cash flow deficit of -$506 million compared to -$252 million in Q2, due to producing more original content. “Self-produced shows like Stranger Things require more cash upfront as we incur spending during the creation of each show prior to its completion and release,” said Hastings. “In comparison, we generally pay on delivery for licensed originals like Orange is the New Black and we pay over the term of the agreement for licensed non-originals (eg, Scandal).”

Netflix had $14.4 billion in streaming content obligations for the quarter, up $1 billion from the second quarter of 2016.

There were positive notes in the third-quarter report. Netflix saw $2.16 billion in revenues for the quarter, a 36 percent increase year over year, with operating income of $106 million and earnings per share of 12 cents. And the subscriber additions were well above its forecast of 85.5 million total subs.

Further, the provider is reaching the end of its un-grandfathering process – raising subscription prices for existing customers by up to $2 monthly – with 75 percent of its subscribers now paying the current full monthly rate.

For the fourth quarter, Netflix is remaining somewhat moderate with its subscriber forecast, saying that it will see about 5.2 million net additions globally, with 1.45 million in U.S. and 3.75 million internationally.

Content-wise, Netflix is sticking to its guns on producing original series and movies. In 2017, the SVOD provider will release over 1,000 hours of original content compared to 600 hours this year, and is expanding its content budget to approximately $6 billion in 2017. Hastings believes that original content will pay off in the long run because “self-producing is less expensive (including cost of capital) than licensing a series or film, as we work directly with the creative community and eliminate additional overhead and fees. In addition, we own the underlying intellectual property, providing us with global rights and more business and creative control.”

Still, the CEO warned that while 2016 is looking solid financially, the first quarter of 2017 won’t look as rosy as Q1 2016 did. That’s because the Netflix won’t have the bounce it got from adding 130 countries to its service list.

Shares of Netflix jumped 20 percent on the Nasdaq to $119.29 in after-hours trading immediately following the announcement.