- Data on international broadband speed and addressable market is supportive of sustained growth.
- Given data in Latin America and European churn, I believe international adoption remains highly likely.
- Furthermore, the roll out of original 4K programming coincides with various other technologies implying sustained ASP growth.
The commentary on Netflix's (NASDAQ:NFLX) international ramp was fairly positive with promising data on both usage and survey respondents to key questionnaires from various investment banks. Over the past couple days Netflix has moved considerably higher. While 1H’16 results aren’t going to be remarkable, the phase-in of higher pricing both domestically and internationally paired with a compelling content slate makes Netflix far more viable as an investment opportunity.
I think what really stood out was the commentary on international ramp-up as estimates centered more on ex-China rather than including China into broadband household estimates. This has been the case across the board, as the investment banks I currently receive NFLX research from have broadly excluded Chinese impact, i.e. Morgan Stanley, Piper Jaffray, RBC and UBS.
I think the opportunity is vastly understated, if we include subscriber mix from China and India. But, given the slow traction in achieving a license to operate in China and the need to develop local partnerships with companies like Baidu and Alibaba, I’m hesitant to specify when Netflix will launch in China. But, I believe the impact from those markets will be significant given the unparalleled scale of Netflix’s content, and the rampant growth of the emerging middle class in both of these markets.
Since, I focus specifically on broadband (cable) households and not baseband (mobile), I believe the addressable market for households can be derived by the growth in wireline subscribers. Basically, if a consumer can afford wireline, it’s likely that said consumer is in a tier 1 city within China, India or any other emerging economy and has enough disposable income to afford video streaming services. Since broadband implicitly has higher speeds and pertains specifically to fiber or cable to the premises, the speeds are generally above 5 Mb/s downlink, which is fast enough for HD streaming. When looking at international markets speeds in some of the bigger emerging economies like India and China, the two average at 2.5 to 4.5 Mb/s on the downlink respectively. This is the lowest among regions surveyed with significant broadband households, but is still fast enough to stream HD content in most instances.
China and India have lower speeds due to densification, which will require next generation technologies like fiber to fully address the bandwidth issues. Since fiber is expensive it’s possible to install fiber within a local area and then branch the fiber with thicker copper cable direct to the residence to reduce cost. This method is being employed by cable companies in the United States. For example, Cox Communications is rolling out fiber via a fiber link and a thicker last mile copper link to the premise and is expected to drive next-generation data speeds at a fraction of the cost.
HD streaming requires 3 to 5 Mb/s downlink (figures vary between HBO, Amazon and Netflix). So, given those limitations, I don’t anticipate much adoption of the higher-tier UHD or 4-screen packages in the emerging markets (as data usage will exponentiate with more devices running streams concurrently), but I do see the basic and standard tier viable for many broadband consumers both economically and from an infrastructure perspective.
The growth rate in the international segment will vary by quarter due to the timing of launch, mix of original content releases and number of global licensing agreements. However, given the fact that the vast majority of high-budget film is concentrated within the U.S., the appeal of action or comedy genres continues to reappear across broad geographic surveys from the Investment banks. After all, movie studios in the United States operate with multi-hundred million dollar budgets, which makes licensing these titles extremely expensive and requires a U.S. subscriber base to support an export opportunity to foreign markets. In other words, Netflix is the only company with a viable (large enough) subscription base that can support U.S. film licenses and re-runs for U.S. shows internationally and can also do the reverse with local programming that then gets exported from various regional markets.
According to Michael Olsen from PiperJaffray the trends in Latin America are very supportive and indicative of growth in rest of the world (developing economies):
We recently surveyed 2,000 internet users in Brazil (1,000) and Mexico (1,000) regarding awareness and interest in Netflix. We found that only 8% of people in these countries have not heard of Netflix, 21% are planning to become Netflix subscribers in the next year, and 7% were subscribers at some point, but canceled. In our view, these are all favorable metrics; 92% brand awareness among internet users after ~5 years in market provides evidence of an effective marketing strategy, 93% retention of subs suggests a relatively low churn rate, and 21% of internet users expecting to sign up for Netflix in the next year (in addition to those already subscribing to the service) compares favorably vs. our estimate of 15% (excluding China) market share in international markets by 2020.
It’s worth noting that 21% of respondents intend to subscribe at roughly the five-year mark (Latin America was first launched in 43 countries late 2011), which implies that above 20% penetration is feasible over a five-year time frame in other emerging economies. The data on emerging markets was positive, and intentions on subscriber churn in developed markets across Europe were also… positive. According to Mark Mahaney from RBC, it was mentioned that 25% and 22% subscribers were unlikely to cancel their subscriptions in Q2’16 in France and Germany, which compared to Q4’15 at 22% and 16% respectively. France improved by 3 pts whereas Germany improved by 6 pts over a 6-month timespan (roughly), which is a fairly solid improvement in usage intention over a short time span, as these markets were initially offered in Q4’14 (roughly a year and a half ago).
The daily consumption rate has steadily increased across all demographics and geographies, according to UBS. The cumulative investment into original content will reach $15.6 billion by 2020 and cumulative original content will surpass 8,500 hours by 2020, according to UBS analyst Doug Mitchelson. Now, keep in mind that this 8,500-hour content library can be streamed in 4K, and with the average episode length of 30-minutes to 1-hour, the sheer amount of content is roughly equivalent to perhaps 12,750 4K episodes of various television shows or 850 seasons assuming 15 episode seasons. Since roughly 1/3rd of U.S. households are expected to have 4K-sets by 2019 according to IHS, the timing overlaps quite well with Netflix’s ramp-up of UHD content.
I also believe many of the developed economies will improve average bandwidth speeds due to the adoption of hybrid fiber and cable to the premises, which makes 4K content a viable market opportunity when combining trends in data speed, penetration of 4K devices, and the size of the content library by this specific time frame. Therefore, both international and domestic pricing tiers will shift to the premium tier, which drives ASP closer to $12 in many of the developed economies (pricing is roughly 10% higher in many of the European economies) by 2020.
Given trends in data speed, adoption, surveys in both Europe and Latin America there’s very little indication that the long-term trajectory has changed. While the recent reports on international subscribers were somewhat underwhelming, I believe many of the factors driving adoption will balance out into a more predictable trend with adoption exceeding many models in a China & India scenario.
With enough upside catalysts and predictable retention trends, I continue to reiterate my high conviction buy recommendation and $133.42 price target on Netflix stock.