Higher Pricing, Geographical Expansion To Drive Netflix Growth

  • Netflix’s cost structure is more or less manageable, but short-term factors like entry into new markets may weigh on cash flow.
  • Netflix’s pricing structure is expected to improve with added pricing tiers, which will expand margins due to content being the biggest cost component of operating expenditures.
  • The business has yet to saturate a meaningful amount of its geographic mix, which gives encouraging outlook on potential subscriber growth.
Higher pricing tiers and expansion to drive Netflix growth

Netflix (NFLX) continues the international roll out of its service, with emphasis put on Europe, and Latin America. During a recent technology conference, Netflix characterizes the total addressable market both domestically and internationally, and puts in context the impact of pricing increases both in terms of short-term and long-term elasticity. The business continues to exhibit reasonable growth potential on the basis of pricing increases and subscription growth. However, short-term risks have weighed on Netflix stock valuation, as content licensing will require Netflix to enter into many more multi-year agreements, which will put some pressure on solvency if Netflix over indulges in content spend ahead of whatever revenue will be generated in future accounting periods.

Higher priced subscription tiers and Netflix’s off balance sheet liabilities

During the RBC Capital Technology Conference, the CFO David Wells articulates in much better detail the impact from a sales mix shift to higher pricing on subscribers, and the amount of liabilities that it has off the balance sheet. Admittedly, the off balance sheet liabilities and current liabilities move through the cost structure at a rate in which expenditure for content is around 70% of total revenue. If content spend exceeds 70% of revenue, the company’s free cash flow tends to dip.

Wells (Netflix CFO) is pretty adept at managing the current cost structure, and elaborates in more detail on the amount of investment it takes to enter into new markets, and at what point the company will be able to reach break-even in many of the new markets that it’s currently entering into.

Quoted from David Wells (CFO of Netflix):

 So we will expand internationally if we continue to be successful, and we’ll expand more aggressively the more confidence we have, that that’s the right business decision and that we will be successful in those markets. If those two things are true, and the larger we expand internationally, the more pressure it’s going to place on cash, because the larger of the loss we’re going to have. So it’s not a free cash flow positive event to continue to launch in these international markets.

Mark Mahaney from RBC Capital Markets goes on to ask:

And last question, when do you have enough scale in international markets such that your – that the cash requirements start declining?

David Wells responds:

It will be – it will be, at least, a year or two; it will be a couple of years likely.

With the firm continuing to expand internationally, the business exhibits a lot of growth potential, but at the same time, Netflix cash flow metrics aren’t going to impress investors. Front-end investment will deflate earnings metrics, because both content and marketing hits the income statement through both amortization and operating expenditure. The back-end infrastructure is outsourced to Amazon Web Services, so even the sever overhead is covered in operating costs, and is not a capital expenditure.

The CFO also mentioned during the RBC Capital Conference that short-run pricing elasticity isn’t the same as what consumers might be willing to pay over the long haul, and that it still has more room to increase pricing without loss of revenue. In other words, Netflix has further room to maximize its profitability, as it releases additional pricing tiers over time. Admittedly, adding more devices, and having HD content made available will drive incremental revenue without much increase in the variable cost. After all content licensing eats up 70% of cash inflow, and since the cost is more or less fixed during the accounting period, the added tiers for both ultra high definition, and high definition doesn’t drive as much impact to the cost structure of the business, even as Netflix is able to generate both higher margins and added revenue from launching those higher tiers.

Wells also mentions in the conference that the company addresses around 40% of an 800 million global addressable market (in terms of broadband households not individuals). This means that Netflix’s current geographic mix can reach 320 million households currently, and with global subscriber streaming figures at 53 million, the company has 16.5% penetration into its current market. On global aggregate, the company has 6.6% penetration, and with the market expanding at a fairly high rate due to increases in broadband households and emerging middle class workers, economic tailwinds also look favorable.


With factors like higher pricing tiers, potential market expansion, and entry into additional markets being material drivers to growth, the stock exhibits a lot of growth potential. However, the business also faces some financial risk due to the way its content licensing deals are structured, and if in the event revenue growth cannot keep pace with content agreements that were made in advance, Netflix will either have to raise debt, or increase pricing to keep current with account payables. However, the likelihood of Netflix mismanaging its cost structure is very unlikely, as the company doesn’t enter into too many new contracts, and adds obligations as it gets closer and closer to airing windows corresponding to the company’s current fiscal year.

Show Full Article
5 2
Is this article helpful ?    

The views expressed in the article are of individual authors and are not necessarily supported by Amigobulls.We do not hold any stake in the aforesaid stocks. Please read our detailed disclaimer.

Amigobulls Disclosures & Disclaimers:

This post has been submitted by an independent external contributor. This author may or may not hold any positions in the stocks discussed. Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. Amigobulls has not verified the author’s positions in the stocks discussed, and does not provide any guarantees in this regard. The author may be paid by Amigobulls for this contribution, under the paid contributors program. However, Amigobulls does not guarantee the authenticity or accuracy of the information provided by the author in this post.

The author may not be a qualified investment advisor. The opinions stated in the post should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions.

Amigobulls does not have any business relationship with any of the companies covered in this post. This post represents the views of the author/contributor and may not reflect the views of Amigobulls.

show more

Comments on this article and NFLX stock

Do share this awesome post