Netflix Earnings Preview: Revenue And Subscribers Set To Grow Even As International And Content Expansion Erodes Profitability

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Netflix (NASDAQ:NFLX) is set to release its first quarter results on April 18. [1] Even though the competition in the online video streaming industry is intensifying, Netflix is still reporting strong growth in revenues and subscribers across both domestic and international markets. However, as the company expands further into international markets and develops new original content, its profitability has taken a hit. Even so, we expect that the company will continue to report growth in subscriber numbers in a highly competitive market.

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Netflix’s International Growth Story Continues

Netflix’s international growth has been exceptional, and its subscriber base has grown by more than 14 million in 2016. [2] The number of total subscribers grew by 50% to 44.37 million in 2016. The subscriber growth has been helped by the company’s aggressive expansion plan. The streaming service is now available in more than 190 countries across the world. The Asia-Pacific market holds a lot of promise for Netflix, as the region offers a potential target market of around 280 million households (assuming one high-speed internet connection per household). [3] The company is taking several steps, such as partnering with telecom service providers to drive adoption, to achieve higher subscription rates. We believe that Netflix will experience healthy adoption rates in international markets on the strength of its original content, competitive pricing and new initiatives.

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However, Netflix’s international operations are still unprofitable as the company continues to invest heavily in its expansion. Its international margins have improved from -127% in 2012 to -6.6% in 2016. We believe that Netflix’s international segment will start to break even by the end of 2017.

Domestic Market Expanding Less Rapidly, But With Higher Margins

The U.S. Subscription Services division makes up 56% of our price estimate for Netflix’s stock. Netflix’s domestic subscriber base crossed the 49 million mark in 2016 and is still growing at a steady pace, having added 4.7 million new subscribers during 2016. We expect that this trend continued in Q1, with the domestic subscriber base growing further.

Additionally, Netflix’s domestic streaming margins have continued to improve, growing to 36%  in 2016. We expect that this trend continued in Q1 and margins improved during the quarter.

Focus On Content Expansion To Escalate Costs In Q1

With so many players in this industry, content is likely to be the key differentiator going forward. Netflix is focusing on original programming to develop a competitive edge, and has a long-term goal of ensuring that nearly 50% of the content streamed on its platform is original. The company plans to develop 1600 hours of original content in 2017 and has a budget close to $6 billion for its programming slate. We estimate that Technology & Development Costs will increase in Q1 as a percentage of total revenues, as some of this content goes into production.

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Notes:
  1. Netflix to Announce First-Quarter 2017 Financial Results, Netflix Investor Relations []
  2. Netflix’s Earnings Filings []
  3. List of countries by number of broadband Internet subscriptions, Wikipedia []