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Investment Overview for Netflix (NASDAQ:NFLX)
WHAT HAS CHANGED?
- Netflix's international surge
Netflix’s international growth has been exceptional so far, and the subscriber base has grown by close to 12 million people in the last four quarters. Netflix launched operations in Australia and New Zealand in March 2015, and Spain, Italy, and Portugal in October 2015. In the first week of January 2016, the company expanded into 130 new countries and now has a presence in close to 200 countries. Additionally, Netflix has been targeting the Asia-Pacific in a big way, and the company entered its first Asian market when it launched into Japan last September. South Korea, Singapore, Hong Kong, Taiwan, and India were some of the other major markets that Netflix launched into as part of the January 2016 global launch. The one notable exception is China and the company is doing all that it can to enter this lucrative market. We believe that Netflix will eventually enter China by collaborating with a local partner. The Asia-Pacific holds a lot of promise for Netflix as the region offers a potential target market of around 280 million households. We believe that Netflix will experience healthy adoption rates in the newly launched countries on the strength of its original content and its competitive pricing. Netflix’s international subscriber base has grown from 1.9 million customers in 2011, to more than 34.5 million by the end of Q1 2016. Taking a long-term perspective, we believe that Netflix can cross 80 million international subscribers by the end of our forecast period.
- International margins under pressure due to rapid expansion
Netflix’s international streaming margins have improved steadily over the years, climbing from -116% in 2011 to -8.5% in 2014. However, the margins were put under pressure last year because of unfavorable currency movements and the additional costs undertaken due to aggressive expansion. The trend of negative international streaming contribution margin has continued in 2016 as well. The figure came in at -16% for the first quarter and the company expects it to be around -11% for the next three months. The company intends to complete its global expansion phase 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.
- Deal with Comcast can help subscriber growth
In 2016, Netflix and Comcast entered into an agreement under which the latter will allow Netflix in its X1 platform, making it easier for Comcast subscribers to access Netflix. While Comcast and Netflix have not been on good terms for the past few years, this deal makes Comcast Netflix’s biggest cable partner in the U.S. This deal will give Netflix access to 30% of Comcast’s video customers – more than 7 million viewers who were using X1 set top boxes as of January 2016. Comcast expects this number to reach 50% (more than 11 million) by the end of 2016. As Netflix faces tough competition in the U.S., and faces a stagnant subscriber base, this deal should fuel its customer acquisition efforts.
Below are key drivers of Netflix's value that present opportunities for upside or downside to the current Trefis price estimate for Netflix:
Netflix's U.S. Streaming Subscribers: Currently we forecast Netflix's U.S. streaming subscriber base to increase from around 44.7 million in 2015 to more than 61.0 million by end of our forecast period. There could be more than 10% downside to our price estimate, if this figure remains below 50 million instead. This could happen if the market growth for streaming slows down, and competition weighs heavy in the future. On the other hand, there could be around 10% upside to our price estimate if Netflix blows past expectations, and captures around 70 million U.S. subscribers.
Domestic Streaming Contribution Margin: Currently we forecast this figure to rise from about 35% in 2014, to close to 43% by the end of our forecast period. However there could be a downside of about 10% to our price estimate if the figure was to reach only 36%. On the other hand, there could be upside of about 5% if this figure was to increase to 48% instead.
For additional details, select a driver above or select a division from the interactive Trefis split for Netflix at the top of the page.
Netflix offers video rental service in the form of DVDs, as well as online streaming to U.S. customers. The company also offers streaming services in international markets and is currently available in about 200 countries.
Netflix's content is available for streaming through a variety of devices such as PCs, Macs, video game consoles, tablets, and smartphones. The company is consistently working towards striking more content deals in order to improve its online library.
In the case of DVDs, Netflix's customers can choose the videos they want to rent from an online library available on the company's website. Unlike traditional video rental businesses, such as Blockbuster and Redbox, Netflix does not have any store locations and instead delivers DVDs through postal mail.
The majority of Netflix's value is currently hinged on its U.S. Streaming services for the following reasons:
Firstly, the DVD subscribers are expected to decline significantly in the U.S., while streaming subscribers are expected to grow. The home video market is growing in the U.S. and streaming is the best way to tap it given the proliferation of multiple internet-enabled devices. Netflix has seen rapid adoption of its streaming plans in the U.S. Although the competition is intensifying, Netflix remains a leader in the streaming segment.
Secondly, the international streaming business is currently a relatively lower value contributor, but this is expected to change in the future as the US streaming market becomes saturated. Netflix has expanded into around 200 countries. The progress has been so strong that the company now believes it can complete its global expansion phase by the end of 2016 while managing to still be profitable.
There is very clear shift of video consumption to the Internet, and Netflix is one of the companies leading this change. The company's DVD subscribers are declining and future growth will come from streaming subscribers. Eventually the company would like to replace all of its physical DVDs with online library.
Netflix entered Canada towards the end of 2010 with its streaming-only service. In 2011, it witnessed good adoption in Canada and consequently expanded to Latin America. In early 2012, Netflix launched its streaming service in the U.K. and Ireland. Following that success, the company also expanded to the Nordic countries of Norway, Sweden, Denmark, and Finland. Netflix expanded its service to The Netherlands by late 2013, and launched in Germany, Austria, Switzerland, France, Belgium, and Luxembourg by late 2014. The company launched into Australia, New Zealand, Spain, Italy, and Portugal in 2015.
In the first week of January 2016, the company expanded into 130 new countries and now has a presence in close to 200 countries. Netflix is targeting Asia in a big way and the company entered its first Asian market when it launched into Japan in September 2015. South Korea, Singapore, Hong Kong, Taiwan, and India were some of the other major markets that Netflix launched into as part of the January 2016 global launch. While the international market presents a huge potential, it also presents obstacles, such as low broadband penetration and speeds, local competition, and content licensing complications.
Increasing Competition in Online Streaming
Netflix has been facing increasing competition in online streaming. Along with Amazon and Hulu, CBS and Comcast have also entered this space. HBO launched a stand-alone subscription service in 2015, and is expected to be a significant competitor to Netflix in the future. Dish and Sony have launched their own internet MVPD (multichannel video programming distributor) services. The growing competition can not only put pressure on Netflix's subscriber growth, but also increase content costs due to bidding by competitors.
Growing Focus On Improving Content and increasing Original Content
Netflix’s original content has improved the perception of the overall brand. The company’s original programming has garnered critical acclaim by scoring multiple Emmy, Golden Globe, and Academy Award nominations, and several wins in the last two years. Shows such as House of Cards and Orange Is The New Black are drawing a lot of audience, and attracting customers to sign up. Netflix has effectively marketed these exclusive shows to maintain its subscriber momentum.
Netflix plans to build on the success of its programming by growing the percentage of its content spending dedicated to original content in the future. The company will launch 600 hours of original content in 2016, up from about 450 hours it released in 2015. Netflix plans for new seasons of 30 or so original series, eight original feature films, 35 new seasons of original series for kids, a dozen documentaries, and nine stand up comedy specials for 2016.
Besides investing in original content, Netflix also signed a deal with Disney (NYSE:DIS) in 2012, to gain access to its content. During 2013, Netflix continued to expand its streaming content through deals with Turner Broadcasting, Warner Brothers Television Group, DreamWorks Animation, and Hasbro Studios. In November 2013, Netflix and Marvel Television (a subsidiary of The Walt Disney Company) announced a five-season deal to produce live action series focused on four Marvel superheroes. Films featured on Netflix include titles from DreamWorks, Relativity Media, Open Road Films, FilmDistrict, The Weinstein Company, Sony Pictures Animation, and Walt Disney Studios Motion Pictures (including Walt Disney Pictures, Walt Disney Animation Studios, Pixar, Lucasfilm, and Marvel Studios) among others.
Trefis Forecast Rationale for Content Acquisition Costs (As % of Total Revenues)
Netflix constantly keeps upgrading its content library to keep it current and to attract more subscribers. It has an edge in this over video rental stores like Blockbuster, which typically take a little longer to add new titles to their catalog.
Content acquisition cost refers to the expenses incurred by Netflix to acquire new titles.
Content acquisition costs went gone down from nearly 16.9% of revenues in 2007 to 13.9% in 2010. Although Netflix has continuously acquired titles, its revenues have grown at a faster rate due to fast growth in subscriber base.
However 2011 saw a significant increase in these costs and the figure amounted to 21.8%. This figure more than doubled in 2012, standing at close to 44%. Going forward, we expect slight increase as Netflix spends more on original and exclusive content.
We considered the following factors for this forecast:
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- Netflix's increased focus on acquiring online content will result in more spending
- Netflix's deal with Epix in 2010, added additional $200 million of annual content acquisition expenses for the company for next 5 years.
- This indicates that growing importance for streaming content will result in content owners demanding more money.
- Netflix has signed several deals with companies such as Disney, CBS, Viacom and Time Warner, consistently enriching its online content.
Cost of acquisition of titles might inch upwards
- Netflix faces increasing competition from cable operators and other content distributors who want to get the latest content as soon as possible
- Cable operators like Comcast are especially aggressive as they seek to develop their Video On Demand (or VOD) services
- This means that studios might charge a premium for providing the latest content
Acquisition of exclusive new shows
- Acquisition of exclusive new shows is something that Netflix is now venturing into, causing stir in the media industry.
- One such example is successful bid of 'House of Cards' where the company outbid other competitors like HBO
- The company continues to add more such content, which is likely to come at a higher price.
- Europe expansion
- Netflix's content costs have skyrocketed in 2012 as the company expanded to European markets. We expect it to continue international expansion and that is an expensive strategy unless that international subscriber base becomes large enough.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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