Netflix ( NFLX ) will release its Q4 2013 earnings on January 22nd. We expect the overall contribution margins to increase and the growth in net domestic streaming subscriber additions to remain flat. As far as the international business is concerned, we expect some acceleration in net subscriber additions driven by improved content, brand awareness and partnerships with local pay-TV companies. While the topline growth may be impressive, we have to be aware of the resulting financial impact and how that trends this quarter. Netflix's streaming content obligations have grown notably in recent years. The figure increased from $4.97 billion in Q3 2012 to $6.50 billion by the end of the third quarter of 2014. That's roughly 1.5 times the revenues that the company is expected to earn in 2013. This is certainly a concern and it will be interesting to see if Netflix can put a cap on it, or at least slow down the rate of increase.
Our price estimate for Netflix stands at $232 , implying a discount of about 30% to the market price.
Seasonality And Launch Of Lillyhammer Season 2 Likely To Lift Net Subscriber Additions
The fourth quarter is seasonally stronger for Netflix which suggests that we are likely to see a strong sequential jump in net subscriber additions. As far as domestic streaming is concerned, the mid point of guidance indicates that Netflix may gain a little over 2 million net subscribers, which is roughly in line with the figure for Q4 2012. The quality of streaming library, which is benefitting from the addition of original content, is likely to be the key growth driver. Netflix launched season 2 of its successful original series Lillyhammer during Q4, and we believe this would have been incremental to Netflix's expansion in the U.S.
Looking at the past few quarters establishes the importance of Netflix's investment in original content. The launch of Arrested Development helped offset the negative impact of seasonality in Q2, and TV series such as House of Cards , Lilyhammer, Hemlock Grove and Orange is the New Black, drew large audiences and attracted customers to sign up. Netflix has been effectively marketing these exclusive shows to maintain its subscriber momentum. This year, the company plans to premiere a second season of House of Cards, Hemlock Grove, and Orange is the New Black, and debut Sense 8 and several kids-focused original programs.
Consolidation In International Markets Likely To Reduce Losses
We expect Netflix's international contribution loss to come down by 10%-15% as the company consolidates its position in Europe, Canada and South America. The operating gain will be visible as the initial content investment will be spread over a larger revenue base resulting from the increase in the number of streaming subscribers. In 2012, the international contribution loss averaged roughly $97.29 million per quarter. During the first nine months of 2013, the quarterly average came down to $72.35 million. We expect this trend to continue. The customer response, especially in Europe and Canada, has been good and Netflix has grabbed some critical deals to ensure subscriber growth. For instance, the company bagged a deal in the U.K. in September, partnering with Virgin Media, which is now offering Netflix's service to its pay-TV subscribers. This could pave the way for more such deals and give a strong boost to Netflix's business in Europe.
Impact From Growing Competition
An analyst from Macquarie recently stated that Amazon ( AMZN ) has confirmed it has over 20 million Amazon Prime members globally. The company has been competing with Netflix for a long time in the online streaming business but had been mute about its membership base. The revelation suggests that it has become a force to reckon with, and could spell trouble for Netflix in the coming quarters. Amazon has also started taking advantage of its distribution capabilities to expand its streaming business and plans to sell set-top boxes of its own. This could have a mitigating impact on Netflix's growth.
Our price estimate for Netflix stands at $232 , implying a discount of about 35% to the market price.
Streaming Content Costs as % of Revenue
Total Content Costs as % of Revenue
Streaming Content Obligations as % of Revenue
Total Streaming Content Obligations ($ Million)
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