Netflix Price Estimate Revised to $549 Based On International Expansion Potential

Netflix (NASDAQ:NFLX) is working tirelessly in order to take its international expansion plans to fruition. The company reportedly held talks with Chinese online broadcasting companies about bringing its content to China. ^[1] No deal has been made public yet but this development could pave the way for Netflix to enter China’s booming online video industry. The company also posted strong numbers in its quarterly earnings announcement on April 15^th. (You can read our earnings review here.)  Subscriber growth exceeded expectations as the company added a record 4.9 million subscribers for the first three months of 2015 to take its subscriber total past 62 million globally. ^[2] User engagement was also at an all-time high and subscribers streamed 10 billion hours in Q1 2015. ^[3]

Netflix is already an established player in the U.S. online streaming industry and we believe that the company will continue to make inroads into the international online streaming space as well. We are revising our price estimate for Netflix to $549 based on the following analysis.

See our complete analysis for Netflix

Netflix’s International Expansion Is Gathering Pace

Netflix has stated previously that the company intends to expand into 200 countries by the end of 2016 and China seems a lucrative market to get into. China’s online video market grew 77% in 2014 and generated 23.97 billion Yuan ($3.88 billion) in revenues. ^[4] The online market is expected to triple and reach  90 billion Yuan ($14.5 billion) by 2018. Entering the Chinese online video market will give Netflix access to a potential market of about 56.5 million broadband households. (See our detailed analysis here – China Makes Sense For Netflix, But It Won’t Be Easy) In comparison, the company’s launch in France, Germany, Austria, Switzerland, Belgium and Luxembourg last year gave it access to about 66 million broadband households. ^[5] We estimate that China’s pay-TV penetration was under 60% in 2014. (See how we estimated this figure here) In comparison, the pay-TV penetration in the U.S. is around 84%. ^[6]  This is an indication that pay-TV penetration is relatively low and this scenario will benefit Netflix.

Going forward, Netflix’s international expansion could have a significant impact on both its subscriber additions as well as contribution margins. The company launched operations in France, Germany, Austria, Switzerland, Belgium and Luxembourg in September 2014, which gave it access to a potential market of about 66 million broadband households. ^[5] In March 2015, Netflix launched its services in Australia and New Zealand and met with a positive initial response. The company is also poised for a fall launch into Japan, a country of 36 million broadband households, behind only China and U.S. (Related – A Closer Look At Netflix’s Foray Into Japan) Other than China, there are some other Asian countries with fast Internet service that Netflix could venture into later, including Hong Kong, Singapore and South Korea. The subscriber growth in the International segment has been very robust so far, with the subscriber base increasing from 1.9 million customers in 2011 to approximately 21 million as of March 31, 2015. ^[2] We believe that Netflix can cross 61 million international subscribers by the end of our forecast period if it continues on its current expansion plans.

Netflix’s international operations are still unprofitable as the company continues to invest heavily in its expansion. However, the markets that Netflix launched into prior to 2014 (Canada, Latin America, the UK, Ireland, the Nordic countries and the Netherlands) became profitable on a contribution basis in Q3 2014 and continue to grow. ^[7] The company acknowledges that progress has been so strong that it now believes it can complete its global expansion over the next two years while managing to still be profitable. This is possible as Netflix will start experiencing operational efficiencies as it grows operations in the target countries. The marketing expenses will also come down as a percent of sales once the company establishes itself in these countries. We believe that Netflix’s international segment will start to break even by 2017 and will start having positive contribution margin from 2018 onward. It will then stabilize at current domestic levels by the end of our forecast period.

Lower Weighted Average Cost Of Capital

We have revised our discount rate (or weighted average cost of capital) downwards for valuing Netflix’s stock. This is the rate at which we discount the company’s future cash flows, and is the weighted average of its after-tax cost of debt and cost of equity. This figure is a measure of a company’s risk. Netflix justifies this revision as the stock’s beta has come down in the past year. Beta is a measure of company’s stock volatility relative to broader market. Netflix’s correlation to the broader market has improved, which means that the risk of fluctuations in its stock price has come down. The company has also been able to stabilize its business and increase its revenues without taking on substantial debt. Netflix’s total long term debt currently stands at $2.4 billion, which is significantly less than the company’s enterprise value of $37.14 billion as of May 22, 2015. ^[8] This reduces the risk in the company and warrants the revision.

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1. Netflix in Talks to Take Content to China, May 15, 2015, Wall Street Journal [↩]
2. Netflix’s SEC Filings [↩] [↩]
3. Q1 15 Letter to shareholders, Netflix Investor Relations [↩]
4. 2014 Sees Huge Rise in China Online Video Revenues, February 28, 2015, iResearch Consulting Group [↩]
5. Q3 14 Letter to shareholders, Netflix Investor Relations [↩] [↩]
6. U.S. pay-TV penetration flat at 84% of homes … and Netflix has little to do with it, study says, FierceCable [↩]
7. Q4 14 Letter to shareholders, Netflix Investor Relations [↩]
8. Netflix Enterprise Value, YCHARTS [↩]