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Netflix Investing Heavily to Add Subscribers

Posted on Thursday, Feb 18th 2016

Netflix (Nasdaq: NFLX) appears to have hit a bit of a roadblock as it continues to grapple with a saturated domestic market. The company plans to address the issues through content and geography expansion. But all of that comes at a cost.

Netflix’s Financials

Q4 revenues increased an impressive 23% over the year to $1.82 billion, but fell short of the Street’s forecast of $1.827 billion. EPS of $0.10 was significantly ahead of the market’s projections of $0.02 for the quarter.

The increase in earnings was partly driven by the growth in average prices. Netflix saw customers switching to its higher-priced option that allows for streaming content in 4K or Ultra-HD. The subscription costs $11.99 per month compared with the $7.99 a month basic option.

International revenues accounted for 31% of the quarter’s revenues and grew 46% over the year to $566 million. Domestic revenues improved 21% over the year to $1.11 billion. DVD revenues continued to decline and fell 16% to $151 million.

During the quarter, Netflix added 1.56 million subscribers in the US and 4 million in its international business. The Street was looking for a net addition of 4.95 million subscribers of which 1.62 were expected to be domestic consumers. Netflix ended the year with more than 74.76 million subscribers internationally with 70.84 million paid members.

For the first quarter, Netflix expects to add another 6 million subscribers and forecast streaming revenues of $1.81 billion. EPS is expected to be $0.02, again short of the market’s expectations of $0.04.

Netflix and Amazon

Netflix appears to have a strange relationship with Amazon. The two are fierce competitors as both offer streaming services for video, TV shows, and their own digital content. But now Netflix is a big customer for Amazon as well. For the past seven years, Netflix has been migrating its data centers onto the Amazon cloud. They completed the migration recently and shut down their last data center. By shifting to the cloud, Netflix can increase its digital footprint much faster than it was able to do so with the physical data centers.

Netflix’s Domestic Growth Issues

Netflix now appears to be finding it difficult to grow its US market. The company acknowledged that subscriber gains in the US market were becoming harder as net additions for the quarter were significantly lower than those reported a year ago. For the recently reported quarter, Netflix recorded an addition of 1.56 million domestic subscribers compared with the 1.9 million additions reported a year ago. For the current quarter, Netflix forecast an addition of 1.75 million US subscribers compared with 2.28 million reported a year ago.

It doesn’t help that competition in the market is increasing. Besides Amazon’s Prime Video service, last year, Hulu and Alphabet’s YouTube Red became big competitors as well. Last year, Hulu began offering an ad-free streaming option at $11.99 a month. Prior to this, Hulu had an ad-supported option at $7.99 a month. Hulu is also acquiring original content or exclusive subscription video-on-demand rights for content and added programming from Turner Broadcasting, Viacom, and Epix Cable. They announced a tie-up with Showtime network to provide access to ad-free Showtime TV shows, documentaries, movies, and sports for $8.99 per month as an add on service for its existing Hulu members.

Last year, Alphabet announced the release of YouTube Red, a paid subscription that costs $9.99 a month and allows viewers to watch content ad free. Earlier this year, Alphabet also announced plans to add original content to YouTube Red.

Netflix plans to address growth by building its content library. In 2016, Netflix is planning spend $5 billion on original content programming given the strong success reported by its existing original programming. During the year, Netflix plans to produce 30 original series, 8 movies, 35 series for kids, 12 documentaries, and 9 stand-up comedy specials.

Netflix’s International Expansion

Netflix is also increasing its focus on the international markets. In the last quarter, Netflix launched in Japan, Spain, Portugal, and Italy. Earlier this year at the Consumer Electronics Show (CES), Netflix announced the launch of Netflix everywhere in the world expect in China, North Korea, and Syria. The service is available in prices comparable to their existing plans and Netflix has added support for Korean, Arabic, and simplified and traditional Chinese languages. The move brings Netflix to 130 countries worldwide besides the 60 that the service already operates in. That makes Netflix truly the first global digital content provider. The release of the service also added another 190 million potential households to Netflix’s target market.

But the international expansion is not free of controversy. Netflix continues to offer its services at prices similar to that in the US i.e. an average of $10 per month for new subscribers. The same price point may not be viable for emerging and poor economies like those of India. That is the reason why Netflix claims that its initial target consumer will be an outward-looking, affluent one with international credit cards and smartphones.

Additionally, Netflix’s streaming service is highly reliant on the ISP’s data streaming capabilities and there is a marked difference in the Internet speeds globally. According to Akamai’s State of the Internet report, South Korea offers speeds of 20.5 MBPS whereas India offers one of 2.5 MBPS. For Netflix to deliver high speed streaming on India’s broadband will be a problem. The company was in talks with ISPs in India to allow for Netflix specific packages that would allow consumers to stream Netflix at higher speeds. But that would lead to Net Neutrality issues, a concern that Indian authorities appear to be highly motivated about.

Finally, content censorship will also become a challenge as was seen in Indonesia. Last month, Indonesia’s state-owned and largest telecom service provider Telkom barred access to Netflix in Indonesia. It claimed that the company did not have the required licenses to operate in the country and that Netflix’s content was violent and of an adult nature.

The market wasn’t too impressed with Netflix. The slowing domestic consumer addition coupled with the pressure of rising costs and the execution problems in International markets made the stock fall. The stock is currently trading at $94.76 with a market capitalization of $40.56 billion. It touched a high of $133.27 in December and a 52-week low of $58.46 in April last year.

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