Netflix Is Now Global: But Is China’s Market Key For Its International Success?

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Netflix (NASDAQ:NFLX)  is now available in more than 190 countries across the world, thus becoming truly “global”. Although the company continues to explore its options for providing the service in China, it went live in more than 130 countries on January 6, 2016, in addition to the 60 countries where it previously operated. [1]. The company plans to make its content available at the same time to members everywhere around the world and added Arabic, Korean, Simplified and Traditional Chinese to the 17 other languages it already supports. According to our estimates the international streaming segment contributes to nearly 30% of Netflix’s valuation and will be one the key growth drivers for the company in future.

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High Growth Market But Strong Local Competition In China

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China’s leading internet and mobile video service provider iQIYI (an independent subsidiary of Baidu) announced that its paid streaming subscribers had doubled to 10 million between June and December 2015. [2]. The country is witnessing explosive growth in paid online streaming subscriptions due to several factors including a crackdown on unlicensed online content and premium original content being offered by streaming services.  Netflix has a tremendous opportunity in China, which has the largest number of internet users in the world.  Indeed, China has more than 600 million internet users, with less than 50% internet penetration, compared to the less than 300 million figure for the U.S., with more than 85% internet penetration. [3]. However, several local players including Chinese ecommerce giant Alibaba have entered the online streaming market in the region, making it an extremely competitive space for Netflix to carve its share.  Reports suggest that the company will look at partnering with a local player to enter the Chinese market and this strategy might give it a competitive edge in the region. According to iResearch, in 2014 the total transaction value of China’s online video market was $3.88 billion.  This represents an increase of 76.4% over the same prior year period; moreover,the  transaction value is projected to reach nearly $15 billion by the end of 2018. [4]. While we expect Netflix’s international subscribers will increase from more than 40 million in 2016 to nearly 71 million by the end of our forecast period, a successful debut in China can improve the pace of this increase.

Regulatory And Content Costs Can Put Pressure On International Margins

As Netflix expands in several countries, it will have to meet regulatory and censorship requirements which are different in different regions, which could lead to higher administrative costs. Furthermore, in order to ensure that its content is available in all regions, the company might have to re-negotiate deals to provide for global distribution. Content costs might increase as the company tries to cater to regional needs, acquiring region-specific content.  If these costs are not offset by subscriber expansion, it can put pressure on the margins. We expect the international segment to break even by the end of 2017 and generate a contribution margin of 30% by the end of our forecast period, as the company gains operating leverage and lowers marketing costs.

 As Netflix re-negotiates deals to make its content available globally, it will have to adapt its marketing efforts in new regions while complying with local regulations.  Just when  the “global” Netflix can make its international operations truly profitable will depend on how fast it is able to increase its subscriber base in these regions.  China is something of a wild card. It offers a high growth market, indeed.  However, it only can contribute to Netflix’s profitability if it is able to gain competitive edge in the region and gain market share from strong local players.

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Notes:
  1. Netflix Is Now Available Around the World, Netflix Media Centre, January 6, 2016 []
  2. iQIYI  Announces Paid Subscribers Reach Ten Million, PRN Newswire, December 10, 2015 []
  3. Internet Users, Internet Live Stats []
  4. China Online Video Market In 2014, China Internet Watch, March 2015 []