In a joint venture widely considered to be a preemptive strike against Netflix (NASDAQ:NFLX), Singapore-based telecom giant Singtel recently partnered with Sony (NYSE:SNE) Pictures Television and Time Warner's (NYSE:TWX.DL) Warner Bros. Entertainment to launch a video streaming service, known as HOOQ, across Asia.
HOOQ will initially launch in Indonesia, the Philippines, India, and Thailand in the first quarter of 2015, and then expand to other markets like Singapore and Australia.
At launch, HOOQ will offer customers over 10,000 movies and TV shows from Sony and Warner Bros., including films like Spider-Man and Harry Potter, and popular TV shows like Friends and Gossip Girl. It will also offer an extensive library of Indian, Chinese, Thai, Filipino, Indonesian, Korean, and Japanese content.
HOOQ could threaten Netflix's plans to expand in Asia, which also plans to expand to Australia and New Zealand later this year, and into South Africa by 2016 .
Why Netflix needs Asia
Netflix is currently available in 14 countries across North America, Latin America, and Europe, but must keep expanding overseas to offset slowing growth in the U.S.
The majority of Netflix's members are in the U.S. (69%), while the rest are overseas (31%), but Netflix's international revenue last quarter rose 76% year over year to $388 million, accounting for 30% of its top line. By comparison, Netflix's U.S. revenue only rose 24% to $917 million. For the current quarter, Netflix expects both international and U.S. growth to slow to 59% and 22%, respectively.
Meanwhile, the number of Internet users across Asia has soared over the past few years, creating a fertile market for streaming services. In the second quarter of 2014, 46% of the world's Internet users were in Asia, yet the penetration rate was only at 35%. By comparison, North America, South America, and Europe have respective penetration rates of 88%, 57%, and 71%. As Asia's Internet penetration rate rises, the region could become the largest market for streaming services in the entire world.
Singtel is well-positioned to capitalize on this market. The company's network currently has around 500 million subscribers, boasts a presence in 25 countries, owns Australia's second largest telecom company (Optus), and holds a major stake in India's Bhartel Airtel -- all of which provide a firm base from which to launch HOOQ. That could be bad news for Netflix, which only has 54.5 million paid members.
Easier said than done
Unfortunately, Netflix can't expand aggressively into Asia due to pressures on its bottom line. Between the fourth quarters of 2013 and 2014, streaming content obligations (the amount that Netflix promises to pay film and TV studios to secure content) rose from $7.3 billion to $9.5 billion. To reduce its licensing costs, Netflix started producing original content, some of which was quite expensive. The first seasons of House of Cards and Marco Polo, for example, cost $50 million and $90 million, respectively.
As a result of rising content costs and expensive original content, Netflix's operating income fell 21% year over year to $65 million last quarter. Over the past five years, Netflix's expenses have dramatically risen as free cash flow has fallen.
Those numbers suggest that Netflix can't respond to HOOQ's Asian expansion in a timely manner. However, the longer Netflix waits, the more traction HOOQ is likely to gain.
And since HOOQ is a joint venture, Singtel won't have to pay Sony and Time Warner licensing costs. Time Warner's involvement also opens up the alarming possibility of its new streaming service, HBO Go, merging with HOOQ and expanding across Asia.
While those developments could certainly hurt Netflix's chances at expanding across Asia, its strengths shouldn't be overlooked.
First, Netflix isn't tethered to a single telecom company, so it can strike multiple deals across Asia and launch its app quickly on set-top boxes, mobile devices, or smart TVs. Second, Netflix's original shows, like House of Cards, were never released in Asia, but are surprisingly popular due to high levels of piracy. Although that sounds like bad news for Netflix, it raises brand awareness for its original content. As Asian governments crack down on piracy, more viewers could sign up for Netflix when it finally arrives.
Last but not least, Netflix might disrupt local VOD services in Asia by simply undercutting their prices. StarHub TV and Singtel's MIO, two widely used VOD services in Singapore, both require long-term broadband contracts and additional monthly fees, which can cost considerably more than Netflix's $9 per month fee.
Make no mistake, the Singtel deal could become a major roadblock for Netflix's plans to expand across Asia. However, there's not much Netflix can do right now but keep an eye on the situation. For now, investors should watch Netflix fares in Australia, which will be an overlapping market with HOOQ, to see if it can effectively compete against Singtel, Sony, and Time Warner.
Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of 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.