Seeking Alpha
Profile| Send Message| ()  

Netflix, Inc. (NFLX) has been investing a lot of effort into international expansion, which I believe is an important key to its long-term survival. However, in this article I want to discuss that while international expansion is important, Netflix should be careful not to over-expand. Acquiring new subscribers costs money, and Netflix needs to make sure that revenue generated from new subscribers exceeds acquisition costs. One good way to ensure continued revenue generation is to focus on Netflix' core USP, which is its Original Series content. Therefore, I believe that right at this moment, Netflix should focus on producing Original Series content to balance its international expansion efforts.

2011: The year with tepid subscriber growth

The year 2011 was difficult for the company as rising costs led to an increase in prices which ultimately led to a steep fall in subscriber growth. It had a big impact on the company's financials causing a significant drop in its value. The increase in costs led to falling margins, affecting the stock price. The company is now focusing on online web content and emerging markets to increase its subscriber base and margins. I believe that with a large untapped customer base outside the US, it is the way to go forward.

Netflix international expansion key to its revival

Netflix planned to expand and is targeting Latin America, Europe and Asia to fuel its growth. In 2011, it had started its revival by expanding outside the USA to increase its subscriber base. At present the current subscriber base outside the USA contributes very little towards the company's revenues and its value. I believe that Latin America will be the biggest market outside the USA for Netflix because of growing middle class families having high disposable incomes. On Sept. 22, 2010, Netflix started its first service outside the U.S. in Canada.

Latin America

With large households, high disposable incomes and shifting consumer preferences, Latin America is the biggest opportunity for Netflix to drive its growth. Netflix has already established a loyal fan base in Latin America since it started its services in Sept. 2011 and is trying to consolidate by resolving certain local issues. If Netflix can overcome them it will increase the subscriber base significantly.

Europe

Europe has high internet penetration, large number of movie buffs and huge population to cater to. In Jan. 2012, Netflix expanded to the UK and Ireland and in the later part of 2012 to Norway, Denmark, Sweden and Finland.

Key Future Potential Region: Asia Pacific

Outside Latin America the biggest growing economies are in Asia. China, Indonesia and India can be the biggest drivers of Netflix growth if segmentation targeting and position is done adequately. These countries have favorable demographics, growing incomes and with internet penetration increasing rapidly, can be the biggest market for Netflix outside the USA. The company can be highly successful if it works on local customization keeping in mind the preferences of people in these countries. If Netflix is able to capture market share in these countries it will get a huge subscriber base. So, the next future potential region for expansion for Netflix is Asia Pacific.

Netflix's Stock Analysis

Netflix stock was trading at a 52 week low of around $55 in August 2012 but, with the announcement of the positive Q4 2012 results on January 23, 2012, the stock is enjoying an upward rally and is currently trading around $181 as can be seen in the chart below.

(click to enlarge)

Netflix's Stock Movement (Source: Google Finance)

2012: Substantial Subscriber Growth and Outlook for 2013

Netflix added more than 10 million subscribers in 2012 while taking the total number of international subscribers over 6 million. The total revenue for 2012 increased to $3.6 billion as compared to $3.2 billion which can be mainly attributed to the revenue generated from new subscribers. The increase in expansion costs led the net income to decrease to $17 million for 2012. Talking about the International segment, there has been a 216% increase in net subscriber additions from 2011 to 2012. The revenue of the International segment has increased almost 2.5 times from $82 million in 2011 to $288 million in 2012. The net loss (international segment) of $389 million for the year 2012 was within the guidance level. The loss is due to increased investments in streaming content and marketing programs to drive more subscriber growth and viewing in international markets. The outlook for the year 2013 is a decrease in losses in international markets as subscriber growth will exceed the growth in content spending. Netflix's Outlook for Q1 2013 gives a guidance midpoint of $87 million in international losses, with expected improvement of $18 million over the previous quarter.

Source: Netflix Q4 12 Letter to shareholders, Netflix 10K Report 2012

Recommendation

I predict a further upside movement of Netflix stock by the end of this year. This growth will be driven by positive fundamentals and future outlook of Netflix.

Hurdles in success

Netflix will face increasing competition from other content providers which are coming up and building up their customer base, especially from the likes of Amazon (AMZN) and Verizon (VZ).

The Road Ahead

Netflix added over 6 million international subscribers by the end of Q4 2012 and hence, taking the total subscribers to over 33 million. Netflix has to understand that with each new subscriber, especially outside the USA, there is a higher cost of acquisition, and a proper cost-benefit analysis is necessary before rampant expansion. The revenue and profit generated per international subscriber acquired should exceed the cost of acquiring that subscriber in the medium to long term. As of now, Netflix should focus more on creating innovative and new content for its subscribers than on adding more international subscriber. I believe that in the later part of 2013 or early next year it can focus on expansion once again. Creating content is important since the competition from Amazon and Verizon is cutthroat. It faces stiff competition from Amazon Prime and Hulu Plus. Netflix has signed a deal with Disney (NYSE: DIS) for creating content for its video streaming business.

If we look at the streaming content on Netflix, we will notice that it has three major types:

1. Movies from one to fifty years old

2. Prior seasons of current TV shows and complete prior season of off-air TV shows

3. Original series only available on Netflix

Now, it is the Original Series which is the USP of Netflix and this is the category which will bring in the future growth and revenue. Since it is a differentiator for Netflix from its competitors, Netflix should focus on creating great original series content.

Source: Netflix: International Expansion And The Road Ahead