Netflix (NASDAQ:NFLX) has made some big announcements in the past two weeks regarding its expansion into Latin America and that it is raising prices on its bundled DVD and streaming packages. While we are currently updating our $153 estimate for Netflix’s estimates, we have nearly tripled our price estimate during the course of the last 15 months. We believe that the market is overestimating the growth in some of keys drivers and underestimating the threat of competition from companies like Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Hulu, Google’s (NASDAQ:GOOG) Youtube and Dish’s (NASDAQ:DISH) Blockbuster.
Below we highlight three areas where we think market forecasts are too optimistic.
1) Expected Subscriber Additions
This is the most important driver that determines Netflix’s value. A major portion of Netflix’s stock price increase in the past year is due to an acceleration in subscriber growth. We believe that the market may be valuing Netflix based on expected subscriber growth in the short-term, which will likely remain on the high side. On the contrary, our valuation is based on long-term expectations for growth, and this leads us to question how much Netflix can grow its user base overall.
Comparison With Other Subscription Services
Our conservatism regarding subscriber growth partially stems from the fact that the biggest subscription services in the U.S., AT&T (NYSE:T) and Verizon (NYSE:VZ), have close to 100 million subscribers. More importantly, these telecom companies offer services to individual subscribers whereas Netflix is more like a household subscription service.
One might argue that Netflix will soon launch individual subscriptions, but if that happens, the average fee per subscriber would go down as Netflix would charge a minimal additional fee per additional subscriber. In effect, a reduction in the fee per subscriber will neutralize the additional benefit from increased subscribers as the U.S. market gets saturated.
Potential Subscriber Gain From International Expansion May Not Be Enough
Netflix claims that it has seen success in Canada, but Canada is a very small market. Therefore a lot will depend on how the company does in Latin America which is still unclear. While the improving state of broadband in this region is likely to aid Netflix, it still might not be adequate in many regions. Moreover, Netflix might need a great deal of local content as well in order to be successful here.
If we think beyond Latin America, United Kingdom is one of the markets that the company could expand to. In one of our articles we examined the potential in this market and it seems like the addressable market in the UK stands at only a small fraction of the U.S. In addition to this, Amazon’s acquisition of Lovefilm in Europe is likely to give Netflix a worthy challenge.
Competition to Emerge
Netflix has proved that there is a big market for older content and all that is needed is good execution. Others are looking to follow this path but haven’t been able to do so yet. Future competition could emerge from stronger competitors like Amazon, Apple and Google that could develop their services to an extent where they could seriously challenge Netflix’s growth.
2) Average Subscriber Fee Dropping
As Netflix expands internationally and promotes its streaming-only plan in the U.S., the average fee per subscriber is likely to come down thereby offsetting some revenue growth due to subscriber additions.
The company this week announced that it will split out its streaming and DVD bundled service raising prices from $9.99 to $15.98. This will encourage users to pick one or the other rather than stick with both, thus driving down the average fee per sub. Before the announcement, we believed that as the streaming library gets larger, customers who are currently on hybrid plans are likely to switch to these lower priced streaming plans. Whether or not Netflix can continue to raise prices across all subscription tiers, remains uncertain at this point.
3) Content is Going to be More Expensive
Content is getting increasingly expensive for Netflix. Part of this stems from content owners realizing that they should be charging more for their content. In addition to this, as more competitors bid for titles, the bid prices are likely going to increase as we have seen in the past, which will affect Netflix’s profits.
