Is this Netflix's Best Opportunity to Profit?

Netflix can grow its total addressable market significantly through expansion in Europe and this will drive big upside in its stock price.

Jun 9, 2014 at 9:00AM

Netflix's (NASDAQ:NFLX)plan to expand into Europe in 2014 is going into full gear.  As a result, the addressable market of Netflix will increase significantly with this expansion into large European markets.  A larger subscriber base should translate into stellar earnings growth for Netflix.

Massive European expansion
Netflix is already the world's largest Internet TV network with operations in more than 40 countries, and now it is about to get bigger. Netflix will be broadening its footsteps with roll-outs in major European countries that include Germany, France, Switzerland, Belgium, Austria, and Luxembourg in the latter half of 2014.

In the last quarter, Netflix saw its revenue from international streaming grow 88% year-over-year to $267 million. And large-scale expansion in big economies like Germany and France will grow Netflix's addressable market and enable the company to maintain its revenue growth abroad. Netflix does not just offer movies and shows from Hollywood, it also offers lots of local and regional content as well. Netflix also offers original shows like Lillyhammer, which is targeted to European audiences, as well and it will bring back the show for a third season. 

Netflix took a significant stride in Europe in 2012 with launches in UK, Ireland, Norway, and many other European countries. High-quality original shows like House of Cards and Orange is the New Black should appeal to a wide variety of European audiences. 

International competition and profitability
It's worth noting that over-the-top on-demand video streaming services are not as popular in some regions of the world as they are in the U.S. and consumers in Europe might need time to get used to them. But the company provides a very compelling value proposition for consumers. An all-you-can-eat subscription service without commercial interruptions and delivered through the Internet for a low monthly price should have wide appeal in the European region.

Netflix bears have previously stated that the company has been losing a lot of money in its international operations. Netflix had been posting large contribution losses as the company slowly built out the infrastructure and added lots of country- and region-specific content for international markets.

Netflix's contribution margin (or the amount left after paying variable costs ) loss stood at  54.2% in the first quarter of 2013 for its international segment, and based on the company's guidance for the second quarter of 2014, its international contribution loss margin should be 3.9%. And Netflix should finish off the second quarter of 2014 with 13.6 million international subscribers. So the company is rapidly moving toward profitability in the international segment, and incremental subscriber growth from newer territories would go a long way in that endeavor. Netflix's major competitor in over-the-top video streaming, Amazon.com (NASDAQ:AMZN), also recently broadened its footsteps in Europe. 

Amazon had been offering video in the UK and Germany under Lovefilm but in the last quarter it rebranded the service as Prime and raised subscription fees.  Amazon disclosed that it had north of 20 million subscribers and also raised the price of Amazon Prime in the U.S. to $99/year. But Amazon recently started investing heavily in getting high-quality content from HBO, as well as a number of Amazon originals from its own production studios. So Amazon and Netflix will be competing with each other in Europe but their increased bets on differentiated content will make their respective services more unique in the eyes of consumers.

Playing offense on net neutrality
Netflix has been very vocal about its displeasure for having to pay Comcast (NASDAQ:CMCSA) to maintain the quality of online video streams for Netflix's customers. CEO Reed Hastings has expressed that he is against the megamerger between the country's biggest cable operator, Comcast, and the second biggest, Time Warner Cable, arguing that the joint company would have Internet control over 40% of U.S. homes in a CNBC interview. The merged company would have immense pricing power not only over consumers, but also over OTT players like Netflix, Google's YouTube, Hulu, Amazon Prime, etc. which offer video streaming services that consume lots of bandwidth.

And in the wake of uncertainty about the FCC's review of net-neutrality laws, ISPs like Comcast and Verizon are cashing in because they receive $70-$80 a month from each customer for Internet connectivity, and also want to get paid by online video companies. This dual standard of ISPs will be a very bad thing for consumers because they have to pick up the tab on both sides. And strong net-neutrality laws will ensure that video companies won't have to pay ISPs to provide the services for which they receive payments from customers. 

In addition, Netflix recently started letting consumers know that their ISPs -- Comcast, Verizon, etc. -- are responsible for slow video streams, and consumers are becoming more informed about ISPs' dual revenue streams. Even if Netflix ends up cutting deals with ISPs and continues to pay them, the costs would make up a small portion of its total revenue and shouldn't impact the company's earnings significantly.

Going forward
The world's leading Internet TV network will be adding substantial amounts of new subscribers so its customer tally will rise from 48.4 million. The company is fighting back on net neutrality and expanding into Europe with large amounts of original and exclusive content that should appeal to many new subscribers. Netflix should do very well in the years ahead. 

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Ishfaque Faruk owns shares of Netflix. The Motley Fool recommends Amazon.com, Google (C shares), and Netflix. The Motley Fool owns shares of Amazon.com, Google (C shares), 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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