Why Quality Online Content Is Key For Netflix’s Growth?

Content quality will be the key differentiating factor in the online streaming space where Netflix (NASDAQ:NFLX)  operates. With players such as HBO, Dish and Sony entering the market, competition is getting intense and revenues depend primarily on subscriber growth domestically and internationally. While international markets have shown tremendous growth in subscriber base, their contribution towards profitability has not yet begun.  Further, low Internet penetration, lower disposable income and fewer digital devices are some of the obstacles which Netflix faces in its international expansion. The domestic market is huge and unsaturated, thus quality original content which appeals to this market will attract more subscribers and can be a key revenue driver for Netflix in future.

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Increasing Competition In Online Streaming Space

We expect more than 85% of Netflix’s valuation to come from streaming subscriptions in the U.S.  While the company continues to distribute its content via DVD to certain subscribers, subscriptions to its online streaming will be its primary source of revenue. Here, the company faces competition from players such as HBO, Dish, Sony in addition to Amazon and Hulu. This can impact its subscriber growth and put pressure on margins due to increases in content costs. Focus on good quality original content will differentiate players in this market and Netflix has shown its commitment towards high quality original content by planning to triple the number of hours of original content (320 hours) in 2015 compared to 2014. This strategy has improved viewer perception about the company and it is no longer considered as solely a content aggregator.

We estimate Netflix’s U.S. streaming subscribers will increase from around 40 million in 2014 to nearly 60 million by the end of our forecast period, given ample growth opportunities in the unsaturated U.S. home entertainment market.

In November 2013, the company announced a five-season deal with Marvel television (a subsidiary of Walt Disney Group) to produce live action series focused on four Marvel superheroes. These series will be part of a roster of 30+ upcoming original series that Netflix plans to broadcast in 2015 and 2016.Providing such engaging and original content will be the key driver of its subscriber growth in future.

International Market Is Growing But Domestic Margins Are High

Netflix added 3.3 million subscribers in Q2 2015 and has similar expectations for Q3 2015. A significant number of these subscribers came from international markets, where the total subscribers have increased from 1.9 million in 2011 to 23.3 million by the end of Q2 2015.((Netflix SEC Filings)). We expect this figure to reach around 70 million by the end of our forecast period.  The international segment does have a huge growth potential for the company, however it is yet to be profitable.  On the other hand the domestic streaming contribution margin has increased from 14% in 2011 to nearly 30% in 2014 and we expect this figure to be around 40% by the end of our forecast period. The international market also comes with challenges such as low Internet penetration, fewer viewing devices and lower disposable income, which could impact growth prospects.

Given the profitability in the U.S. markets, we believe Netflix’s efforts to increase subscriber base in this region via improved content quality could be the key driver of future growth.

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