On May 19, 2015, NETFLIX’S STOCK REACHED an all time high for the third day in a row. Shares peaked at $628.50 a share. And some analysts expect the price to keep climbing.
"Netflix is quickly becoming one of the most powerful media companies in the world.”
The firm added that the streaming video giant could soon become the next $100 billion tech company.
Wall Street, it seems, sees the future much the way Netflix does—a future where Netflix takes over everywhere. Netflix CEO Reed Hastings said in an earnings call last month.
“Internet TV is growing around the world at incredible rates. And so we’re really propelled by that big macro trend.”
These skyrocketing expectations, and accompanying stock price, are in large part due to Netflix’s rapid expansion abroad—in particular, reports since Friday, May 22, 2015, that Netflix is in talks to expand into a huge new market: China. But as all conquerors know far too well, the path to world domination doesn’t come without resistance. Despite its aggressive growth, the company has already experienced pressure from its European markets to improve its service—and fast.
The Path of More Resistance
Netflix is growing, and quickly, even in its more mature markets like the US, but especially abroad. In the past few years, Netflix has been rapidly expanding to reach beyond US shores. The service now touts more than 20 million international subscribers in more than 50 countries, including the more recent additions of Australia, New Zealand, and even Cuba. By 2017, the company says it wants to be in 200 markets. But even in Europe, Internet speed and access has been a limiting factor. In a recent talk in Germany, Hastings was asked if Netflix would consider a download option so German subscribers wouldn’t have to be dependent on streaming. Hastings’ answer amounted to “no.”
What’s more, if content is king, European subscribers have been markedly disappointed with Netflix’s offerings. In France and Germany, for example, the original content selections are not as wide as those offered in the US, in part due to licensing deals with local broadcasters and distribution rules in different countries. (To get around that, some are opting to use a VPN to access the American service, according to The New York Times.) European filmmakers are also unhappy that Netflix is encroaching on their turf—one recently shouting at the Cannes Film Festival that Netflix “will destroy the film ecosystem in Europe.”
Piracy is another major concern for Netflix abroad, according to the company’s latest letter to shareholders. In the Netherlands, for example, Netflix has seen competition from apps such as Popcorn Time that make illegal streaming as easy as a legal service. (Netflix has called the app’s success in the Netherlands “sobering.”) In fact, House of Cards has become hugely successful in China thanks to pirating.
More World to Conquer
Rather than being deterred, Netflix seems to be confronting those obstacles by growing even more. The streaming giant has plans to expand to Japan later this year, and analysts expect the company will try to break into the Chinese and Korean markets soon, too. For any company dependent on subscribers, the biggest fear in any single market is reaching the saturation point. For Netflix—and its share price—to keep growing, the company is betting it will need to continue to expand.
But a new market brings new demands. In its letter to shareholders, Netflix said that early signs indicate that promoting original content helps bring in new members. So, to get new subscribers in France, Netflix is launching an upcoming French-language drama Marseille, advertised as House of Cards for the French. But for an expansion into China, despite being a market already primed to love shows like House of Cards, censorship and stringent regulations on content could prove tough, which is why Netflix seems to be looking to find a partner to smooth its entry.
Netflix has enormously popular original content, the revenue to invest in new shows, and the data to predict the programming subscribers will like best. It’s a recipe for world domination. The company, and now Wall Street, just better hope it translates.
Q1 2015 Earnings Report Highlights
Here are some of the highlights of Netflix earnings report compared to forecasts that were announced on April 15, 2015:
- Earnings per share: $0.77 (adjusted for foreign-exchange rate changes since last year) vs. $0.69 expected.
- Revenue: $1.57 billion vs. $1.57 billion expected; $1.4 billion total streaming revenue; $415 million international streaming revenue.
- Subscribers: 62.30 million vs. 61.44 million forecast; US streaming net additions 2.28 million vs expectations of 1.8 million; international user additions 2.6 million vs. 2.25 million
Netflix shares increased by more than 12% in after hours, largely because of the big increase in new-user additions. It added a record 4.9 million new users globally in the last quarter, bringing total number of users to 62.3 million. Both its US and international user additions beat expectations.
Its total streaming revenue was largely in line with expectations, up about 32% from last year. The subscriber growth was higher than expected as its total paid members came in at 59.6 million, slightly more than the 58.7 million forecast. All in all, Netflix added about 14 million new users over the past 12 months.
Netflix said in a statement.
"We think strong US growth benefited from our ever-improving content, including the launch of the third season of House of Cards and new shows Unbreakable Kimmy Schmidt and Bloodline. In addition, retention continued to improve due to the growing value of our service overall. We are forecasting Q2 US net adds of 0.6 million, similar to the year ago quarter."
In Q4 2014, Netflix launched its streaming service in Australia and New Zealand as part of its plan to finish its global expansion within the next two years. Netflix said it expects to add 1.9 million international users in the next quarter.
Netflix also confirmed that it's seeking shareholder approval for a stock split. Its stock closed at $475.46 per share on Wednesday, April 15.
Here's what Netflix CEO Reed Hastings had to say about the quarter's performance:
"During Q1, higher-than-forecast net adds and US revenue, coupled with lower-than-forecast content spending, resulted in a US contribution margin of 31.7%, ahead of our 30.1% estimate. In 2015, we expect to run ahead of our US contribution margin growth target of 200 bps/year on average because a greater share of global and original content costs will be absorbed by existing and new international territories as we continue to expand globally (since we allocate global content costs by geography).
In addition, starting in Q2 we intend to shift some of our US marketing budget to international to take advantage of the substantial available growth opportunities. This, in the short term, drives down international contribution profits and drives up US contribution profits. We are still targeting 40% contribution margin in the US in 2020.
Our international segment was fueled by continued strong growth across our 50+ countries as well as a successful March 24 launch in Australia and New Zealand, which adds about 8 million1 broadband households to our addressable market. In ANZ, Netflix benefited from high consumer awareness, a fervent fan base for original series like House of Cards and Orange Is The New Black and operator relationships with Optus and iiNet, the second and third largest broadband providers. We expect international Q2 net adds of 1.90 million, up 70% vs. last year. Later in 2015, we will launch additional markets, starting with Japan.
The strong dollar hurt financial results during the quarter, negatively affecting International segment revenue (lower by $48 million y/y using Q1 2014 forex rates) which carried through into a $15M negative forex impact on international contribution loss. These forex headwinds offset better than expected subscriber growth to result in contribution losses close to our expectations. As a reminder, we absorbed on average 5% higher VAT rates across our European markets starting January 1. We’ll have a full quarter of content expenses in ANZ in Q2 and expect the international segment loss to grow to $101 million, increasing throughout the back half of 2015 as we expand to additional markets (consistent with what we’ve said).
Our strong performance led to overall operating income that exceeded our projections ($97m actual versus $79m forecast). Net income was negatively affected by currency-related transaction losses included in other expense; excluding these forex losses, Q1 EPS would have been $0.77 vs. our $0.60 forecast and our actual EPS of $0.38."
Netflix reported total worldwide streaming revenues of $1.4 billion for the quarter, up 7.28% from Q4 2014 and up 31.33% from Q1 2014. U.S. streaming revenues for the quarter were $985 million, up 7.41% from Q4 2014 and up 23.28% from Q1 2014. International streaming revenues for the quarter were $415 million, up 6.9% from Q4 2014 and up 55.43% from Q1 2014.
Profitability and Cash Flow Are Down
Netflix's operating income for the quarter was $97 million, up 49.23% from Q4 2014 and slightly down 1% from Q1 2014. Net income for the quarter was $24 million, down 71.1% from Q4 2014 and down 54.7% from Q1 2014.
Netflix's reported a free cash flow deficit of $163 million for the quarter, this was up 114.86% from the free cash flow deficit of $74 million reported in Q4 2014.
Both profitability and free cash flow have been negatively impacted by higher content and marketing costs incurred to improve its film entertainment offerings and higher marketing and promotions costs in order to increase subscriptions and streamings, particularly as it expands into new markets like Australia, New Zealand and Japan.
Netflix Plans To Enter China
According to Bloomberg, Netflix is in talks with Wasu Media Holding Co (000156.SZ), a Chinese media company backed by Jack Ma and other possible partners as it seeks entry into the country’s $5.9 billion online video market, according to people familiar with the matter.
Netflix has held discussions with companies including Wasu Media Holding about forming a partnership, according to the people, who asked not to be identified because the talks are private. Netflix plans “to be nearly global by the end of 2016,” a spokeswoman, Anne Marie Squeo, said in response to questions about a possible China partnership.
Entering China would allow Netflix to take advantage of what’s forecast to be explosive growth in online television in the nation of 1.4 billion people. The market is expected to almost triple to 90 billion yuan by 2018, according to Shanghai- based Internet consultant IResearch.
A local partnership would be essential given the Chinese government’s strict controls over licensing for online content. Netflix wants a partner that has licenses for content on all devices — including mobile phones, computers and set-top boxes, according to the people. China’s State Administration of Press, Publication, Radio, Film and Television has given Internet TV licenses to seven companies, including Wasu.
Wasu didn’t immediately respond to an e-mail seeking comment. Two phone calls to Wasu’s general line weren’t answered.
Courtesy of an article dated May 19, 2015 appearing in Wired, the letter dated April 15, 2015 to Netflix Shareholders, an article dated April 15, 2015 appearing in Business Insider, and an article dated April 16, 2015 appearing in Informitv, and an article dated May 24, 2015 appearing in The Day