Below Par Growth In Asia-Pacific Could Lead To 10% Correction In Our Netflix Price Estimate

Close to 30% of Netflix‘s (NASDAQ:NFLX) valuation can be attributed to its international operations. Netflix aims to have a global presence by the end of 2016, and we believe that the company can amass 70 million international subscribers by the end of 2022. A significant portion of the international subscriber growth will come from Asia-Pacific as the company should experience healthy adoption rates in the region based on the strength of its original content and competitive pricing. However, this isn’t a foregone conclusion as roadblocks such as piracy, slower internet speeds, language barriers, lower disposable incomes, local competition, etc. could lead to sluggishness in subscriber growth in the Asia-Pacific region. If this scenario comes to pass, our valuation for Netflix will drop from $103 to $91. To help our readers assess the impact, we have created a mini interactive model where they can modify Netflix’s penetration of broadband households in its international target markets to see the change in the company’s international subscribers (select grid view on top right corner for concise view of all drivers and output). Readers can then leverage this generated change and apply it to our valuation model for Netflix to see how it affects the price estimate.

Our price estimate for Netflix stands at $103, which is line with the market price.

See our mini interactive model for Netflix’s international subscribers forecast here

See our complete analysis for Netflix

Our Base Case Scenario: Netflix Experiences Healthy Adoption In Asia-Pacific Region

Netflix’s international growth has been exceptional so far, and the subscriber base has grown by more than 10 million in the last four quarters. ^[1] The streaming giant is currently undertaking an ambitious expansion plan with the goal of having a global presence by the end of next year. ^[2] Consequently, Netflix has been targeting the Asia-Pacific region in a big way. The company entered its first Asian market when it launched in Japan last month and intends to launch in South Korea, Singapore, Hong Kong, and Taiwan in early 2016. ^[3] Netflix is also exploring options for entry into densely populated countries and lucrative markets such as China and India. The Asia-Pacific holds a lot of promise for Netflix, as the region offers a potential target market of around 280 million households (assuming one high-speed internet connection per household). ^[4]

In our base case scenario, we believe that Netflix will eventually launch into all major Asia-Pacific territories by the end of next year and will experience healthy adoption rates on the strength of its original content and competitive pricing. The streaming service also works as a repository which allows for “binge watching,” and its pricing allows for Netflix to be viewed as a complementary service rather than a competing service to traditional pay-TV or other online options. Consequently, we believe that Netflix’s penetration of broadband households in the Asia-Pacific could reach around 5% by 2022, which would translate to an 18 million strong subscriber base in the region.

What Could Happen If Netflix’s Asia-Pacific Bet Underperforms

Netflix’s Penetration of Broadband Households in the Asia-Pacific

Even though we believe that Netflix will experience strong adoption rates in the Asia-Pacific region, this isn’t a foregone conclusion. There are many factors which will affect Netflix’s ability to successfully gain traction within the Asia-Pacific region, some of which we have highlighted below. If these factors manage to overwhelm Netflix’s growth in the region, the streaming service might not be able to achieve the penetration levels we envision in our base-case scenario. If Netflix only manages to achieve a penetration level of around 2.2% by 2022, Netflix will have less than 8 million subscribers in the region as opposed to our base-case projection of around 18 million subscribers. The somewhat disappointing subscriber growth will have a cascading effect on other subscriber metrics. As Netflix will have to dole out more promotional offers in order to induce satisfactory growth in the region, the company’s profitability in the region will decline. As a result, Netflix’s international streaming contribution margin could come down to around 27% by the end of our forecast period. Additionally, Netflix will most probably not be able to suitably hike prices during the later stages of our forecast period because of the fear of customer backlash. All these developments could bring down Netflix’s price estimate to $91, which would be a more than 10% correction to our current estimate of $103.

What Obstacles Could Derail Netflix’s Growth In Asia-Pacific Region

Low broadband penetration, low disposable income, language barriers, fewer digital devices, and general skepticism about watching content on the internet are some of the issues that Netflix will have to face as it tries to gain a foothold in the Asia-Pacific region. Netflix faced similar issues when it first entered the South American countries. ^[5] Netflix also faces competition from local streaming providers in most of the markets it enters. Such local competitors are easily recognizable, do not have a language barrier, and, as a result, are looked upon more favorably by the target audience.

China makes up around 60% of the 280 million Asia-Pacific broadband households that Netflix is targeting, which makes the country extremely crucial to Netflix’s success in Asia. ^[4] However, the company’s entry into China will not be easy as online streaming is a very restricted domain in the country. China’s State Administration of Press, Publication, Radio, Film, and Television has given Internet TV licenses to only seven companies. Netflix would most certainly need to partner up with a company that has licenses to distribute content on all platforms, including computers, mobile phones, and set-top boxes. China also has a very strict censorship policy and the concerned authorities could object to some of the potentially objectionable content in Netflix’s programming. Additionally, overall efficiency and reliability of internet services in developing countries, such as China and India, is inferior to those of developed nations such as the United States.

A major obstacle in Netflix’s path to a successful foray into Asia-Pacific is piracy. According to piracy-tracking firm Excipio, China, India, and Australia are among the list of countries where hit Netflix shows such as House of Cards and Daredevil are pirated the most. ^{[6] [7]} Piracy has a direct effect on the attractiveness of Netflix’s exclusive programming. Subscribers may not be interested in viewing these shows at Netflix’s paid platform, when they can get the same shows for free. Subscriber losses due to piracy could potentially gain more prominence as the company launches into China, India, Australia, and other Asia-Pacific countries prone to piracy. This, coupled with earlier mentioned roadblocks, such as slower internet speeds, language barriers, lower disposable income, local competition, etc., could lead to sluggish growth of the Asia-Pacific subscriber base.

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1. Netflix’s SEC Filings [↩]
2. Q3 15 Letter to shareholders, Netflix Investor Relations [↩]
3. Netflix To Launch In South Korea, Singapore, Hong Kong And Taiwan In Early 2016, September 8, 2015, PRNewswire [↩]
4. List of countries by number of broadband Internet subscriptions, Wikipedia [↩] [↩]
5. Netflix faces problems in Latin America, May 16, 2012. Los Angeles Times [↩]
6. Netflix ‘Marvel’s Daredevil’ Plundered by Pirates, April 16, 2015, Variety [↩]
7. ‘House of Cards’ Season 3 Pirated, With China Top Country for Downloaders, March 1, 2015, Variety [↩]