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Netflix (NASDAQ:NFLX) stock is up more than 6% Tuesday after a report from Variety that the company is licensing its original content to Chinese streaming service iQIYI, which is owned by internet giant Baidu (NASDAQ:BIDU).

NFLX data by YCharts

Netflix has been previously stymied in the Chinese market, as have many other non-Chinese companies, due to the country’s strict regulation of internet traffic, content, and foreign companies’ services. This has restricted companies like Google (NASDAQ:GOOG) (NASDAQ:GOOGL) and Facebook (NASDAQ:FB) from establishing a presence in the country, but has allowed Chinese analogs to thrive. One such analog, often called the “Chinese Google” is Baidu.

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Baidu operates the most popular search engine in China, and offers many other internet-related services, one of which is video streaming. iQIYI boasts a whopping 500 million monthly users and is currently an advertisement-supported platform, though it is trying to shift towards a subscription supported business like Netflix. One way to justify a subscription over competing streaming services, as Netflix has already figured out, is to offer a wide range of original, exclusive content.

The exact terms of the licensing deal, such as when the content will be available or how much the deal is worth, are unknown at this point, but I think the market is correct in giving NFLX a boost because of it. A significant chunk of revenues for content creators comes from licensing out the content to other providers. For example, when Netflix acquired the exclusive rights to stream Disney (NYSE:DIS) films, the deal was estimated to have cost around $300 million. The really nice thing about licensing is that there are minimal expenses to offset the revenue gained from it, and high-margin ventures are a boon for a company like Netflix that is constantly criticized for spending too much cash.

I don’t have an estimate of how much iQIYI is paying Netflix for the rights to its content, but regardless of the actual dollar amount, I think the deal is an important reminder of how valuable Netflix’s original content is. Sure, Netflix isn’t too keen on licensing out its content to competitors or other services right now, but as much of it ages and the competitive advantage of maintaining exclusive control declines, I think we will see more licensing deals.

Also of importance, iQIYI is far and away the leading video streaming service in China. That Netflix has now established a relationship with the company is a boon that could indicate further licensing deals between the two companies for additional original content as it’s created.

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I have seen many criticisms from Netflix bears that the company spends too much of its cash flow on creating original content. I have argued that original content is what gives Netflix its main competitive advantage over other streaming services and is therefore a smart, necessary strategy. However, this licensing deal demonstrates another dimension to original content: it’s not just valuable for bringing in the subscriptions, but can be re-purposed to generate revenue in other ways. With this licensing deal, Netflix is playing the role of curator and provider, which I think will become a more common occurrence moving forward to the benefit of NFLX shareholders.

With that said, there are some hurdles that investors should be aware of pertaining to this deal. First, Chinese regulators have complete control and can block any deal for any reason. There are no guarantees that this licensing deal will be approved by the government even if Netflix and iQIYI agree on terms. Second, the Chinese government also has strict censorship rules that may obstruct Netflix’s content from being streamed in China. It is possible that iQIYI and by extension Baidu have a way around these obstacles, but it is uncertain at this point.

On the whole, I think this development is a positive for Netflix, but investors should weigh these risks before making any investment decisions regarding the stock. Best of luck!

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Thanks for reading!

Disclosure: I am/we are long BIDU.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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