Netflix (NASDAQ:NFLX) reports its Q4 2012 and full year results on January 23, 2013, and we do not expect a lot to change. While we expect losses to continue due to high content costs incurred as a result of international expansion, we anticipate overall subscriber gains to be moderate. The U.S. subscriber growth will be impacted by a seasonally strong quarter as will as increased competition from streaming services such as Amazon Prime (NASDAQ:AMZN) and Comcast’s (NASDAQ:CMCSA) Xfinity Streampix. Netflix should see strong subscriber gains internationally due to its launch in Nordic countries. DVD subscriber losses will continue and we look forward to the company’s guidance for the next quarter or year.
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What’s The Subscriber Outlook?
Netflix’s full year net subscriber additions are likely to be around 5 million for its domestic business. When 2012 began, it looked as though Netflix was getting back on the growth track. But as the year progressed, there were clear signs of a slowdown in expansion even though it had recovered from its 2011 woes. According to the company’s management, the reason behind this slowdown is their overestimation of market growth. However, we believe that competition, especially from Amazon, is playing its part in slowing Netflix’s growth (see The U.S. Netflix Story: Evolving Competition Threatens Growth). In addition, growth is bound to slow as Netflix’s subscriber base increases. As the early adopters and streaming enthusiasts have already subscribed to these services, getting each incremental subscriber is going to be a slow and expensive task. It will take a better streaming catalog and more marketing on Netflix’s part to convince new subscribers to join. Additionally, the decline in DVD subscribers is also causing a dent. However, most of these seem to be converting to streaming-only subscribers as they drop their hybrid subscriptions.
As far as international business is concerned, we expect Netflix to demonstrate robust subscriber additions. Along with healthy acceptance in the U.K., Netflix will benefit from its expansion in Nordic countries of Denmark, Sweden, Finland and Norway. These countries have a combined population of a little under 25 million. Assuming three people per household, this gives a potential market of close to 8 to 9 million that Netflix will aim to capture. Given that competition exists from Amazon and other local players, capturing 20% of the market will be a huge accomplishment. That gives the company close to 1.5 – 2 million potential subscribers. A more optimistic scenario can lead to subscriber gains of close to 3 to 4 million over the long term.
Costs Will Remain High, May See Losses
Netflix hasn’t shown any signs of taking it easy on the content cost side either. The company continues to invest in content, which is essential to retain subscribers. This is especially an issue for its international business. While the company needs strong content to begin with, it can only reap profits once its international subscriber base becomes big enough for the business to make economic sense. These high costs are likely to result in losses in the fourth quarter as well. Netflix’s content acquisition costs (as % of revenues) have skyrocketed from about 22% in 2011 to close to 44% in 2012.
Our price estimate for Netflix stands at $81, implying a discount of about 20% to the market price.