- Estimates were released on Netflix international subscriber growth.
- The estimates by the sell side are more conservative in nature.
- Given the rapid adoption of Netflix historically and ramping content spend, I believe subscriber growth will outpace expectations.
Netflix (NASDAQ:NFLX) continues to pile on the momentum internationally. However, the relative growth of the segments has been a mystery, well up until now. The analysts at Morgan Stanley have put together a comprehensive estimate of the varying subscriber figures across all geographic markets that Netflix currently serves. I still think there’s upside in the form of introducing Netflix’s streaming product to India, China, South Korea among various other Asian/Middle East/African markets.
However, this sets the tone for long-term growth models by sell-side analysts, which puts Netflix in a fairly comfortable position to exceed on earnings/sales models. This really reduces the expectation risk, as Netflix valuation primarily floats on its ability to accelerate revenue growth due to aggressive market expansion rather than margin expansion through reductions in content licensing cost reductions. In years prior to this, analysts were anticipating a quicker ramp to profitability, but even without that operating profit ramp the stock continued to accelerate on speculation over worldwide streaming subscriber growth.
Source: Morgan Stanley
As you can tell, Morgan Stanley is relatively conservative on its growth rate for international subscribers as they model a 20.08% CAGR from 2014 to 2025. Of course, Netflix has accomplished quicker rates of penetration in the United States market alone, which is why I’m a little more aggressive as I have extensively outlined the catalysts/momentum coming out of FY’15.
Historically, Netflix had 0% penetration in digital streaming in 2007 in the United States. However, by the end of FY’16 Netflix had 44.76 million paying subscribers in the United States, which translates to 33.14% penetration over the course of eight years, which is fairly impressive. The current household figure for the USA is 133.957 million according to the 2014 census. Therefore, the penetration increased incrementally by 4.14 percentage points in each incremental year. In the most optimal scenario, I believe Netflix can re-create the same adoption curve.
Of course, Netflix’s execution becomes crucial here as its success was partially owed to the fractured ecosystem of content on the Internet in conjunction with declining consumption trends for the millennial demographic. Therefore, Netflix captured an opportunity in low-cost subscriptions when compared to cable broadcast. However, the pricing advantage Netflix was able to deliver in the United States doesn’t equally compare to the pricing differential to cable programming in other markets. As such, Netflix’s on-demand feature in conjunction with original series becomes far more critical to its international expansion.
As it currently stands, I anticipate Netflix’s total addressable market (TAM) to expand to 700 million households upon the roll out of services in China, Russia, South Korea, Turkey, India, Poland, Taiwan and Vietnam. This will likely occur in the 2016 to 2017 timeframe. This gives the combined addressable market room to expand quite significantly. Furthermore, I anticipate ARPU (average revenue per user) to expand over that timeframe, which is why I’m a little more aggressive when compared to other analysts. Of course, I’m an independent/buy side analyst so I’m a lot more aggressive when compared to sell side analysts.
That being the case, when working off of a 2025 forecast, I walk away with the impression that penetration should reach 41.42% against that global base. Since broadband adoption is growing in a lot of these markets, the total broadband household figure will likely expand from 794 million (current ITU figures) to grow at 5.25% upon expanding into the major emerging economies (India and China) where fixed broadband is growing the quickest. Therefore, I project Netflix's TAM to expand from 700 million to 1.167 billion households, which implies a subscriber figure of 481 million given historic growth rates, which is a lot larger than Morgan Stanley’s estimate of 114 million.
Morgan Stanley anticipates slower subscriber penetration in India and China. However, I feel like Netflix is most competitive in less developed markets as consumers will likely respond to the low monthly pricing when compared to broadcast television. As such, I believe adoption will match U.S. adoption rates. Furthermore, Netflix has an opportunity to organically develop content for these markets as there’s not a lot of native programming in China and India. There’s some high-budget programming, but it wouldn’t match the global scale of Netflix's content licensing/production. So, there’s an opportunity to capture the price conscious consumer assuming strategic execution across all geographic markets.
I continue to reiterate my high conviction buy recommendation and $133.42 price target.