When Will Netflix, Inc.'s International Growth Pay Off?

Since Netflix (NASDAQ: NFLX  ) announced that it plans to expand to six new countries in Europe this fall, investors have been eagerly anticipating its future subscriber growth. However, Netflix investors are also wondering how long it will take for Netflix's new markets to contribute to the company's earnings.

That's a trickier question. The task is made particularly difficult by the fact that Netflix has not provided country-specific profitability data for several years for competitive reasons.

Netflix is expanding rapidly, but this growth is crimping profits in the near term.

Nevertheless, by looking at the maturation of Netflix's international markets as a whole, we can get a fairly good sense of how new markets tend to develop. Assuming Netflix's new markets follow the existing pattern, they will probably turn profitable around 2017.

Netflix's international growth
Netflix began its expansion beyond the U.S. in September 2010, when it launched in Canada with a streaming-only offering. It's hard to believe now, but at that time, Netflix didn't have a streaming-only plan in the United States! Streaming was simply a free add-on to Netflix's DVD-by-mail service.

Netflix has expanded its global footprint significantly since then, with forays into Latin America, the U.K. and Ireland, the Nordic countries, and the Netherlands. Here are the details of Netflix's international expansion so far.

Market

Date of Entry

Age (at 6/30/14)

Number of Broadband Households Today (Estimates)

Canada

September 2010

3.8 years

11.3 million

Latin America

September 2011

2.8 years

60 million

United Kingdom

January 2012

2.5 years

21.5 million

Ireland

January 2012

2.5 years

1.1 million

Denmark

October 2012

1.7 years

2.1 million

Norway

October 2012

1.7 years

1.7 million

Sweden

October 2012

1.7 years

2.9 million

Finland

October 2012

1.7 years

1.6 million

Netherlands

September 2013

0.8 years

6.6 million

Broadband household penetration data from the International Telecommunication Union. 

Netflix is now available to nearly 110 million broadband households outside the U.S., of which slightly more than half are in the developing countries of Latin America, with the remainder in Canada and Western Europe. That compares with roughly 90 million broadband households in the United States. Netflix's international total addressable market is already larger than its domestic TAM.

Estimating time to profitability
Nearly four years after launching its first international market, Netflix is finally on the verge of earning a profit on its international operations. In April, Netflix projected that its international contribution loss would shrink to from $35 million in Q1 to just $12 million in Q2, and that its current international markets as a group would be profitable before the end of 2014.

Using a weighted average based upon the number of broadband households in each market, the average age of Netflix's international markets is 2.6 years. Netflix isn't profitable outside the U.S. just yet, which means it's taking nearly three years (on average) to reach profitability in Netflix's early international markets.

Netflix has to buy the rights for lots of content when it enters new markets.

However, the large size of the Latin American market distorts this picture. It represents more than half of Netflix's current international TAM, but Netflix has had more difficulty growing in Latin America than in developed markets. Household income is lower (even among households with broadband), e-commerce penetration is lower, piracy is common, and the demand for English-language content is lower.

If we exclude Latin America, the weighted average age of Netflix's other international markets is 2.4 years. These developed country markets probably reached the breakeven mark recently. That implies an average time to breakeven of a little more than two years, which is close to Netflix's original goal of turning profitable within two years of opening a market.

(This depends on the assumption that Latin America is still posting losses, but relatively small losses. It seems unlikely that Latin America is profitable yet because of the various problems Netflix has confronted there -- however, if it was still generating lots of red ink, Netflix presumably would be looking to cut its losses and exit the market.)

Projecting profitability in Netflix's new markets
Based on Netflix's experience in its current international markets, it appears to take two to three years for a typical international market to reach profitability. Netflix's new crop of markets -- France, Germany, Belgium, Luxembourg, Austria, and Switzerland -- should be easier to penetrate than Latin America.

On the other hand, Netflix may have a slightly harder time reaching profitability than in Canada and its other European markets. English fluency is much lower in the six new markets than in any of Netflix's current international markets outside Latin America. (Indeed, it's not surprising that when choosing new markets, Netflix picked the low-hanging fruit first.)

Additionally, would-be rivals have had extra time to prepare for Netflix's arrival in these new territories. There is still plenty of room for Netflix to be successful, but it will be battling for users and content from day one, whereas it created the streaming video market in Canada.

All told, it will be difficult for Netflix to turn profitable in its upcoming new markets within two years. A more realistic timeframe is 2.5 to three years. This means that barring any unforeseen shocks, investors can expect the profits to start flowing from Netflix's new markets in 2017.

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Read/Post Comments (4) | Recommend This Article (2)

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  • Report this Comment On June 30, 2014, at 2:56 AM, AceInMySleeve wrote:

    This looks like good analysis. I spent some time today attempting a better sub model for int'l w.r.t to separating the components, but it's difficult to find a lot of certainty with so little data.

    I think it also helps to approach this from the other direction. Why doesn't Netflix deploy the whole globe tomorrow? To the extent it's based on net profitability of international, this would imply accelerating TAM. I suspect just plain management throughput is a chunk.

    I wonder what kind of fun internet politics would pop up if Netflix opened business to Australia but only hosted from servers here in the states.. :p

  • Report this Comment On June 30, 2014, at 10:04 AM, TMFGemHunter wrote:

    I agree that there's a management bandwidth component governing the pace of international expansion. But in the last two years, the pace has been even slower than that. I think Netflix has been "testing" to sort of see how the subscriber base would ramp in different kinds of markets.

    I do believe the top concern is profitability. On an annual basis, I think Reed Hastings wants to post consistent earnings growth. That does mean Netflix could roll out international markets faster as the domestic business matures and becomes more profitable.

    On the other hand, there are a lot of developing country markets that I think Netflix won't touch. Latin America hasn't gone so well, so I don't see Netflix being anxious to open up shop in China, India, Indonesia, etc. even though those are big markets.

    It seems likely that there will be another round of new markets in late 2015, but I'm not expecting anything too radical. Perhaps Netflix will go after southern Europe next. Australia and New Zealand also seem like an obvious (albeit small) target.

    Adam

  • Report this Comment On June 30, 2014, at 9:53 PM, AceInMySleeve wrote:

    Yeah, domestic profitability is a counterbalance, but one may also reason that the current int'l markets which have approached profitability will begin returning contribution profits as well.

    I was trying to reverse engineer growth rates and patterns of each market knowing their broadband populations but it's not particularly easy. It is 100% clear that Latin America had a very slow start. There is also a hint that UK may have slowed a bit after the first year or so, but less clear. And I also think that there was an acceleration recently that's difficult to explain with just the extra TAM of the fairly small newer markets unless those were substantially more productive than UK. I'm guessing Latin America might have accelerated.

    I also tried using Alexa's predicted share of traffic from various countries. They put Canada and Mexico on par which is interesting. I'm not familiar with the biases of that metric (who the heck actually installs Alexa toolbar?).

    I find an interesting question mark how ARPU might fluctuate in certain markets. If you have a narrow but wealthy english-addressable audience that has few choices for english-content do you charge more? Is content much less expensive in markets where Netflix is much stronger at delivering Hollywood content because there was never a good distribution vehicle for it? Clearly the US is very mature at delivering US content.

    While Latin America has done poorly relative to penetration, it may also have a substantially different business model. These are all generic arguments, I don't see any specific evidence for them.

    Hastings has said 'everywhere but China' and I do actually hold that as roughly the expectation. The expansion this year is another ~60M HH and I think they can replicate that in 2015 and 2016 probably keeping to a Sept schedule before you start having to picking up very small pieces. I'm expecting that by 2017 the organization is sufficiently skilled to do that and can maintain a pace of spreading over larger counts of nuanced territories.

    Growth rate globally in wealth and broadband should allow for a nice rising tide growth rate that allows for a fairly nice earnings multiple many years out (of course assuming a more optimistic scenario not disaster).

  • Report this Comment On July 01, 2014, at 6:05 PM, TMFGemHunter wrote:

    Interesting analysis. I am now working on another piece based on today's Goldman upgrade. (I found the GS analysis to be bordering on farcical.)

    I agree that the addition of some smaller markets (the Nordic countries in Oct. 2012 and the Netherlands in Sept. 2013) can't explain the recent acceleration in sub growth. I think you're right that Latin America is a piece of it, but it goes beyond that. Netflix has historically gotten a lot of growth from word of mouth advertising. So it takes a few years after the early adopters join to really hit peak growth.

    Netflix management has even talked about the growth following an S-curve. This is also supported by the U.S. growth trajectory -- the service is quite mature in the U.S. yet it grew more in 2013 than in 2012 and might grow even faster in 2014. The biggest int'l markets (Canada, Latin America, and the U.K./Ireland) are probably still in the accelerating growth phase but may begin to level out soon.

    The $64,000 question is whether Netflix will dominate its int'l territories as much as it does the U.S. That will determine when sub growth will start to taper off.

    Adam

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