Netflix's (NASDAQ:NFLX) expansion outside the US began in 2010, when it introduced its streaming services in Canada. It will now increase its consumer base by launching its services throughout Latin America and the Caribbean. The share price of Netflix declined considerably in 2011, indicating rising costs which led to a decline in profitability and Year on Year subscriber growth. NetFlix's expansion to the Latin American markets is a strategic move to sustain its competitive edge in the long run by growing its subscriber base. In addition, Netflix's global expansion plan presents an opportunity to add more revenue streams and enable them to form new strategic alliances and partnerships that may lead to diversification in the future. However, the current video streaming market outlook and Netflix's cost and positioning structure suggests that it may be time to sell its stock. We underpin our assessment by several reasons stated below.
A Moderate 2012
The potential subscriber growth in the US during 2012 was extremely average, as Netflix faced intense competition from other streaming services such as Amazon Prime (NASDAQ:AMZN), and Comcast's (NASDAQ:CMCSA) Xfinity Streampix. Nonetheless, Netflix is expected to see huge growth from international markets, primarily throughout the Nordic region. During 2012, Netflix certainly exhibited signs of recovery from 2011; however the expansion plan still did not seem completely on track as Netflix only managed to add 5 million paying users in the domestic market. According to Netflix's management, the biggest reason behind the slowdown is the overestimation of the potential market size. Furthermore, the level of competition also increased significantly leaving no breathing room for Netflix. Going forward, the ever reducing DVD subscriber base also contributed to the slowdown.
In contrast to its US performance, we do expect Netflix to post robust growth in the international markets. Acceptance in the UK and the Nordic region seems positive. In these markets Netflix will compete against the likes of Amazon for a paying subscriber base of approximately 9 million users. Assuming Netflix is able to capture a market share of anything from 20% to 25% will enable it to increase its subscriber base by 2.5 million users approximately.
Content Cost may lead to losses
Growth in international markets is highly crucial going forward. To capture a higher market share and grow rapidly in the international arena, Netflix needs to develop high quality content. While investing heavily in content quality is a pre-requisite for international markets, it could only break-even with the content cost if the subscriber base grows large enough. Going forward, high content cost may incur losses in 2013. The content cost grew from 22% to 44% (%of revenues) in 2012.
Netflix currently competes with Amazon and Comcast's Xfinity Streampix in the video streaming space. Amazon has a market cap of $120 billion and offers a variety of product and services. It mainly offers electronics, merchandise, books, and DVDs. Amazon reported a collective revenue and EBITDA of $61 billion and $3.8billion respectively in 2012. Amazon's main revenue stream is electronics and general merchandise as it contributes more than 60% to its overall revenues. Comcast has a market cap of $109 billion and the primary offers are in the space of cable TV, broadband and internet services and NBC & Comcast content. It reported a collective revenue and EBITDA of $63 billion and $21 billion respectively in 2012. The revenue streams for Comcast are uniformly balanced with maximum revenue generated through NBC & Comcast content. Comcast has posted robust growth in the last two years and the company moves into 2013 with a highly optimistic outlook and aggressive expansion plans.
Netflix recently signed a distribution deal with Epix, a premium TV and broadband channel operated by MGM, Lionsgate and Paramount Pictures. This deal can potentially corner down the shipping cost of Netflix in the coming year, leading to an upside in the stock price. The US subscriber base of Netflix in 2011 was approximately 21 million users, however if the subscriber base stays below the 40 million mark then the Netflix share price may experience a decline moving forward. Nevertheless, if the subscriber base blows past the 40 million mark and outdoes all the expectations then the stock value could rise significantly during the 2013 period.
Why we believe it's time to sell the Netflix's stock?
DVD subscribers are expected to decrease in the US moving forward and international business will suffer due to high content cost. In addition, markets such as Latin America have a significantly lower internet penetration compared to the US and Europe combined with a much lower disposable income. Netflix is also likely to face stiff competition from the local more established players currently operating in the Latin American market. This makes quick growth for Netflix a highly challenging task. As we move forward, other internet giants are also expected to enter the video streaming space making it highly crowded and much harder for Netflix to grow its subscriber base in order to deal with its content acquisition cost. The content cost is likely to rise further with the entry of new players due to bidding by several new competitors.