How Low Margins In The International Streaming Business Can Impact Netflix’s Valuation
International streaming division constitutes 27% of our price estimate for Netflix (NASDAQ:NFLX). This is a fairly new business, launched in 2010, and is continuing to expand. However, the division is still making losses and had a contribution margin of -8.5% in 2014. Nevertheless, this still represents a significant improvement from the 2012 figure of -128%. We expect Netflix’s international business to break even in 2017 and the margin to increase to 30% by the end of our forecast period. However, if the company is not able to meet these estimates and the contribution margins were to stay under 20%, the downside to our price estimate can be around 15%. Contribution margins could remain low due to a potential increase in content costs and lack of operating leverage in new countries where Netflix is expanding. Competition from local streaming service providers may force Netflix to spend more than expected. Additionally, some of the new markets may not be as receptive as Europe and North America.
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Our current contribution margin forecast suggests that the international streaming business constitutes 25% of Netflix’s value. In a scenario where this margin were to reach only 20% by the end of our forecast period, there can be a 15% downside to our price estimate. This scenario can be replicated using Trefis Interactive technology
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We expect the international streaming division to be profitable in the long run as its marketing expenses are likely to come down in comparison to revenues, once the brand is established in new territories. This is in line with the company’s expectations of its international business becoming profitable at the end of 2016, once the expansion is complete. However, content costs could also shoot up in the future as the company renegotiates deals and invests further in original content. Also, as Netflix expands to new countries, the incremental contribution of these markets is likely to be in the form of losses due to lack of operating leverage and high initial marketing expenses. There are several other challenges which the company faces in new markets. Competition from local players could intensify in the future. There is widespread piracy in Asian countries, which can impact Neflix’s subscriptions. Lower broadband penetration in Southern Europe and emerging Asian countries could impact the company’s expansion in these regions.
Netflix is in the process of establishing strong international presence and hasn’t shied away from spending heavily on new content deals to do so. While we expect this business to be profitable in the next few years, there could be significant downside to our price estimate if it does not meet our margin forecast.
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