Netflix Q3 Earnings: International Expansion Will Lead Future Subscriber Growth, But International Margins Will Continue To Suffer As A Consequence

Netflix (NASDAQ:NFLX) released its Q3 2015 earnings report recently. While international subscribers increased at a rapid pace, growth in the domestic subscriber base was relatively weak. Our take on Netflix is that its overall subscriber base will continue to grow in the coming years but the rate of growth in domestic subscribers is likely to continue its downward trend due to increased competition and potential market saturation. On the other hand, International subscriber growth will remain robust in the near future as the company rapidly expands into various new territories with the aim of having a global presence by the end of 2016. However, the same rapid expansion will continue to hurt international margins, which will remain negative in the near term. We expect the company’s international segment to start breaking even by 2017 and have positive contribution margin from 2018 onward.

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International Growth Will Offset Slowdown In Domestic Market

Netflix’s international subscriber growth has been robust so far, and we believe that it will continue to remain so in the near future as the company expands into various new territories with the aim of having a global presence by the end of 2016. The company delivered a stellar performance in the international segment this quarter and the subscriber base grew by a record 2.74 million customers. ^[1] The number beat the previous best of 2.60 million additions set two quarters ago. The company expects the growth in subscribers to continue and hopes to add 3.5 million subscribers globally for Q4 2015, much higher than the 2.43 million it added during the same quarter last year. Netflix has been targeting Asia in a big way and the company entered its first Asian market when it launched into Japan last month. Netflix is also working towards an early 2016 launch into South Korea, Singapore, Hong Kong and Taiwan. ^[2] Additionally, the company is also exploring options for entry into densely populated countries and lucrative markets such as China and India. (Related – China Makes Sense For Netflix, But It Won’t Be Easy) Netflix’s international subscriber base has grown from 1.9 million customers in 2011 to just shy of 26 million by the end of Q3 2015. ^[1] Taking a long term perspective, we believe that Netflix can cross 68 million international subscribers by the end of our forecast period if it continues on its current expansion plans.

Netflix has benefitted immensely from the cord-cutting trend in the US. It had a considerable first mover advantage as it was one of the first online streaming platforms to pique the interest of the masses. However, the current online streaming landscape is becoming increasingly competitive. Many content providers such as Dish Network, Sony, Apple, HBO, CBS, Comcast etc., have thrown their hat into the streaming ring and incumbent players such as Hulu and Amazon Prime are ramping up investment in order to improve the quality of their content. In light of the increased competition, Netflix will find it increasingly difficult to add new subscribers at a rapid pace. The company missed its guidance for the quarter, adding 0.88 million new subscribers while it had earlier forecasted 1.15 million new users. ^[3] We believe that Netflix will continue to add new users throughout our forecast period on the strength of its original content and repository qualities, which allow for binge watching. The streaming service also has a tendency of being viewed as a complementary service rather than a competing service to the various other options available for consuming content, whether it be traditional pay-TV or the more recent online options. However, the rate of growth in domestic subscribers is likely to come down compared to earlier years as the US market slowly moves towards the point of saturation.

International Margins Under Pressure Due To Rapid Expansion

Netflix’s international streaming margins have improved steadily over the years, climbing for -116% in 2011 to -8.5% in 2014. ^[1] However, the margins have been put under pressure this year because of unfavorable currency movements and the additional costs undertaken due to aggressive expansion. The international streaming contribution margin came in at -13% for the quarter and the company expects it to be around -21% for the next three months. ^[3] The company intends to complete its global expansion by the end of 2016 and then generate material global profits. This is possible as Netflix will start experiencing operational efficiencies as it grows operations in its 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 around 30% by the end of our forecast period.

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1. Netflix’s SEC Filings [↩] [↩] [↩]
2. Netflix To Launch In South Korea, Singapore, Hong Kong And Taiwan In Early 2016, September 8, 2015, PRNewswire [↩]
3. Q3 15 Letter to shareholders, Netflix Investor Relations [↩] [↩]