Can Netflix Offset Domestic Slowdown With International Growth?

  • Growth in the U.S. is still strong, but getting softer due to high penetration.
  • International growth is rapid, but it comes with a set of challenges - including profitability.
  • Netflix does have a few open doors to explore, and these could tilt the odds in their favor.

If you asked me to name just one company that has been able to adapt to changing situations quickly and effectively, I’d say Netflix (NSDQ:NFLX) without batting an eyelid.

From DVD pay-per-rental to subscriptions to on-demand streaming video, the company is now firmly in the original content production space. With each move, the company has been further entrenching itself in the rapidly growing video consumption market. Today, Netflix stands as a proud pioneer that proved how streaming video could become a huge and scalable business - not only in the United States but also around the world.

The case for video growth and mobile growth is very strong, and Netflix is on the bleeding edge of that growth - and well ahead of new entrants. Competitors like Amazon Prime Video and YouTube Red are only just scratching the surface on original content, and Netflix isn’t going to let that gap get any smaller, which is why they’re pushing into international markets in such an aggressive manner even as their U.S. subscriber base shows signs of maturity.



As you can see from the chart above, their recent quarters have been showing strong growth in the international segment. It does come with its own set of challenges, but for the moment, it is helping Netflix maintain a solid growth rate in global subscribers. From 69 million at the end of Q3 2015, they’re already up to 81.5 million within two quarters, a lot of that coming from international growth.


Where do they stand on revenues?

Top line growth shows some interesting trends, as the table below shows.


The first thing you’ll notice is that even though international markets are growing at a faster pace than at home, they’re losing money.

The main take-away from the segment report above is that domestic profitability is still sustaining international growth. On the upside, growth overseas is strong, and Netflix has the skillsets and avenues to properly monetize that segment and bring it into profitability over the next few quarters.

The issue now is the mature growth pattern that the home market is exhibiting.

The Home Market Threat

From the Q4 Letter to Shareholders:

“In the US, we ended 2015 with nearly 45 million members, although our Q4 US net adds were down year over year, as expected (1.56m actual versus 1.90m prior year). Our high penetration in the US seems to be making net additions harder than in the past.

Our forecast for Q1 US net additions is 1.75m, against a prior year actual of 2.28m. New credit/debit card rollover continues to be a background issue.

In Q2 and Q3, we'll be releasing a substantial number of our US members from price grandfathering on the HD plan and they will have the option of continuing at $7.99 but now on the SD plan, or continuing on HD at $9.99 a month.

Given these members have been with us at least 2 years, we expect only slightly elevated churn. Our 2020 US contribution target remains at 40% and we are already at 34%.”

So there is clearly a saturation issue for Netflix in the United States, as it would be for any paid streaming service with penetration as high as 45 million households. As market leader, they’ve recognized that problem and adjusted their guidance accordingly. However, they still remain optimistic on the 40% U.S. contribution target by 2020; that’s something of a mountain to get over, considering that by then they’ll have both Amazon and Google breathing down their necks with premium original content and massive subscriber bases of their own.

For now, however, Netflix is topping the list on downstream traffic in North America (in Internet terminology, downstream refers to people streaming content to their devices, as opposed to uploading content to a site.)


Source: XStream

How’s that possible, when YouTube (free streaming segment) has far more users than Netflix? The only possible explanation is viewing time. YouTube’s visitors typically watch a few minutes worth of videos a day, while Netflix’s viewing time is much higher because it’s essentially episode-based programing. In fact, one survey showed that a percentage of Netflix subscribers watch up to 5 episodes at a time. And if they’re doing that with multiple series, it will add up.


Source: Apple Insider

For now, I think Netflix is relatively safe in the United States, but that could change over the next few years. They’ve had a very long runway in the paid video streaming market, but that market is now being flooded with financially strong competitors like Google, Amazon and even HBO.

The Overseas Dilemma

The real opportunity for Netflix over the next decade is outside the United States, where they have a footprint across 200 countries. But there’s a big problem they need to solve overseas - localization of content.

Until now, their U.S. content has been driving international growth by capturing pockets of subscribers that want English-language programming. However, that’s not a sustainable model. In Europe, for example, what works well in France may not work for Germany, and vice versa.

The answer to that question may lie in the markets themselves. Opening up to local production houses will give Netflix the kind of content that will be lapped up by local subscribers.

In fact, with 35 million subscribers overseas, even the big boys in Hollywood may start looking at Netflix as an additional launchpad for their blockbuster films. Today, dubbing a movie into multiple languages for multiple markets is a practical way of extending that movie’s reach.

That’s a big opportunity for Netflix if they take that route for their 200 or so overseas markets. People want great content, but most would prefer it in their own language. English-language content does get acceptance in these countries, but the possible penetration dramatically goes up when that same content is available in local languages.

The Case for Investing

No doubt Netflix is a hyper-growth company. With a forward P/E ratio of over 350, that’s a given. Most investors would balk at putting in their money on a bubble that big, and rightly so.

However, there’s a way to get around that. At such a high valuation, the market expects rapid and sustained growth from NFLX. It happened in Q1 2016, for example, just after the earnings call, as you can see below:


Despite the loss, NFLX did manage to once again breach the $100 level about a month later. They have an earnings call coming up later this month (Jul 18, 2016 at 2:00 PM Pacific Time) where you might see a similar trend unless they beat all analyst expectations - something that’s going to be very difficult to do, at least in the U.S. segment.

With a stock such as this, there are only two ways for smart investors to go about it. Either dollar-cost average (DCA) your investment over a 2-3 year period of time, or wait for these “subscription” shockers to temporarily push share prices down low enough for it to become worth your while. The DCA method is slower and requires more discipline, but the objective is the same: keep your cost basis as low as possible while exploiting the growth potential of such hyper-growth stock.

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