Netflix Earnings Report: Revisiting Netflix as a Market Leader

On October 20^th, we published a piece reaffirming our opinion on Netflix, and offering an alternative view on the companies strategic decisions, original programming approach, and market expansion. (Read Full Article Here). This piece is an update following the Jan 20^th earnings call.

INTERNATIONAL OPPORTUNITIES

Following launches across Europe, Netflix [NFLX] announced during its fourth quarter earnings call that it will accelerate its international schedule, with a new goal to increase from 50 to 200 countries by the end of 2016. Netflix believes that it can become the first truly global ‘television network’ while remaining profitable. The incremental cost to enter remaining markets is lower than individual markets entered thus far.

Two developments make further expansion logical: Netflix is acquiring global rights to programming rather than country-by-country, and Netflix original programming is amongst the most viewed programming abroad. Subscribers from new markets add revenue that falls straight to the bottom line, with little additional marginal cost for current programming. International expansion also enhances Netflix as a distribution platform for studios looking to promote their content globally.

As it expands into emerging markets, Netflix delivers a larger value -add than in developed markets. While Netflix is positioned as a quality low-cost alternative provider of video entertainment in most existing markets, emerging markets do not have the same amount of alternative options for quality content. The On Demand concept is not available in less advanced television markets, and Netflix will offer significant value and command pricing power. Latin America is a good example, where Netflix now has over five million subscribers. While impressive, the opportunity is still great, as Netflix currently penetrates less than 10% of broadband homes in the region.

CONTENT

The Netflix algorithmic programming model received positive reinforcement during the fourth quarter from the newest Netflix original program, Marco Polo. Panned by the media with a 30% Rotten Tomatoes Critics Score, Netflix reported that the show has strong viewership metrics and a Rotten Tomatoes Audience Score of 93% (compared to a 96% for House of Cards). Netflix has continuously proven that it knows what its customers want, a positive signal for the 320 hours of new original programming Netflix plans to produce this year. If Marco Polo and others follow similar trends as previous originals, audience growth should pick up significantly for subsequent seasons.

Content cycles should also have a large impact for other Netflix original programming, including House of Cards and Orange is the New Black as they enter their third seasons. Original content generates returns through subscriber growth over time, including in new international markets, but the cost impact is immediate and disproportionate to the present. Despite its much discussed price tag, Netflix original programming is the most efficient content on its platform, costing less per hour viewed than licensed offerings.

MARKET ENVIRONMENT

The market continues to validate the idea that internet video will be in every home within five years. The transition is becoming apparent as television channels become apps and multi system operators (MSOs) offer ‘TV Everywhere’. Netflix is the best positioned to capture the ‘lean forward revolution’. During the past quarter, Netflix enjoyed growth in total hours viewed, and perhaps more importantly in median hours viewed as well. While Amazon [AMZN] offers strong competition with Prime, and HBO [TWX] will release its service later this year, internet TV is not a zero- sum game. Interesting to note, HBO’s subscriber base increased when Starz [STRZA] and Showtime [CBS] entered the premium television market decades ago. Anything that accelerates the pace of ‘cord cutting’ will help attract new customers to all of the services, and create pricing power and tiering options over a much larger pie. Domestically, the $100 billion annual pay television market is the true competition, and its 100 million households the goal. Many markets abroad have no cord to cut, and streaming services will leapfrog undeveloped infrastructure. Because no customer is likely to replace cable with a single service, Amazon, HBO, and Netflix can be viewed as complements rather than substitutes.

To see the rest of the Netflix analysis, click Here to read the original analysis.