Netflix's International Opportunity Is Gigantic

Netflix's International Opportunity Is Gigantic

Netflix's ambitions to grow U.S. subscriber levels to two to three times HBO's levels are no secret. As the company's domestic subscriber base is almost 30 million, major upside potential lies in its international operations. Netflix continues to enter new markets and add more content deals to aid in this endeavor.

Increased optimism
Netflix is gaining subscribers rapidly outside the U.S., and enjoys steady growth in all the countries in which it currently operates. Its growth prospects in Latin America and the European region are stellar, and should aid in narrowing its international losses.

Netflix kicked off operations in the Netherlands recently, and management intends to ramp up content acquisitions in other international markets, all of which should boost net additions. The addressable market in Latin America is sizable, with more than 50 million broadband households. And in the first half of 2013, Netflix doubled its peak downstream traffic in Latin America to 1.94% -- it stood at only 0.8% in the first six months of 2012 -- making Netflix the bandwidth share leader in paid video streaming in the region, according to Sandvine.

At the end of the second quarter, international members stood at 7.75 million, which represents a 114% year-over-year increase. Going forward, if Netflix can add 1.0 million to 1.5 million subscribers per country, which is a pretty reasonable and conservative assumption, its international subscriber base will potentially jump to 40 million to 60 million subscribers. Not surprisingly, a number of sell-side analysts recently boosted their price target for Netflix, citing strong upside potential stemming from international growth, as the company inks partnership deals with cable companies like Virgin Media and Com Hem.

International competition getting thinner's European subsidiary, LOVEFiLM, has stated it has crossed 2 million subscribers. LOVEFiLM had an earlier start over Netflix in the U.K., but Netflix's management said it is slightly ahead in terms of its content library and streaming viewership. LOVEFiLM currently operates in the U.K. and Germany; it shut down its operations for undisclosed reasons in Sweden, Denmark, and Norway in August. LOVEFiLM winding down its business in the Nordic region should be a strong positive for Netflix in that area.

Time Warner's HBO offers a direct-to-consumer platform in the Nordic markets with HBO Go, but Time Warner's management reiterated that HBO Go will not be a solo service in America. HBO content is very distinct from the Netflix product, and the cable requirements for HBO have slowed the growth of subscriptions in recent years.

In the first quarter, HBO added a paltry 50,000 premium subscribers, taking its tally to 28.8 million, according to SNL Kagan. And HBO's growth rate remains well below the likes of Netflix, Amazon, and Hulu. Netflix's management has adopted HBO's playbook in building out a large library of original and exclusive content, and this will aid in beating the competition in regional markets.

The bear case is flawed
Netflix added streaming content that cost $600 million in second quarter, which is below the 2012 average, when the company added content at a quarterly pace of $628 million. As a result, it is reasonable to believe that its content spend will stabilize as it continues to build out its large stable of quality content.

Netflix bears tend to point out that the company's content costs are getting out of hand. But this is not the case. Netflix had total commitments and liabilities of $6.37 billion (including off-balance-sheet liabilities of $3.92 billion) at the end of the second quarter. But its current content liabilities amount to only $2.53 billion, with the rest of the content liabilities being due in five years or more. And these off-balance-sheet obligations will run through its income statement over a long period of time.

As a result, the company's content costs are manageable, as its revenue is much higher and growing at a steady pace of 15% to 20%. Netflix has around $1.08 billion in cash, and can raise additional debt if needed. Even activist investor Carl Icahn stated that some of the sell-side analysts do not understand Netflix, and that he didn't sell a single share of the company. And unlike the business models of other high-flying Internet companies, Netflix's subscription revenue is a lot more stable and predictable.

Going for the long haul
Netflix will be looking to add more international markets contingent upon the firm's global profitability and the growth prospects of the respective regions. And the key drivers for success in the international markets remain the same as in the domestic market, i.e., more consumer adoption and contribution margins at levels similar to those in the U.S. According to its earnings call, the company is already profitable in Canada, and it has a huge growth opportunity in Latin America.

Netflix's increasingly popular brand should aid in competing with local and regional pay-TV competitors. The company's decision to add a lot more localized content in its library for subscribers in different countries will aid in lowering the churn rate, and appeal to a much broader consumer base. This should lead to stellar top- and bottom-line growth over the long term.

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Fool contributor Ishfaque Faruk has no position in any stocks mentioned. The Motley Fool recommends and Netflix. The Motley Fool owns shares of and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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