Why We Revised Our Price Estimate For Netflix To $137

Photographer: Scott Eells/Bloomberg

Netflix’s stock has performed well in the markets in recent months, particularly following its earnings announcement in January. One of the primary reasons for this was growth in international markets – as the company saw over 47% growth in international streaming revenues in 2016 – while the domestic business for the company has largely stabilized. Furthermore, the international business’ margins are improving, which should help boost the company’s overall profitability in 2017. As a result of these developments, as well as other factors, we have revised our price estimate for Netflix upwards to to $137. Below we explain the changes that we have made to our forecast model for the company.

Stable Domestic Subscriber Base, Improving Pricing

According to Trefis estimates, the U.S. streaming subscription business contributes close to 57% of Netflix’s value. The company’s domestic subscriber base crossed the 49 million mark in 2016 and is growing at a steady pace, having added around 10 million new subscribers during 2016.

Netflix faces intense – and growing – competition in the online streaming market, as companies such as Dish Network, Apple, HBO, CBS and Comcast have launched their own streaming services in recent years. Despite the competition, Netflix has been able to maintain a fairly steady growth rate. With the success of Netflix’s original content, its perceived brand value has improved. The company is no longer considered just an aggregator of popular content from other networks, as it now provides engaging and interesting content of its own. Given the secular trends within the pay-TV industry, as consumers increasingly cut the cord in favor of streaming platforms such as Netflix, we expect Netflix’s domestic user base to improve to over 68 million by 2023.

Furthermore, over the past few years, Netflix was able to increase the average fees paid by subscribers without any material impact on subscriber numbers. We expect that the company will be able to increase its monthly streaming subscription fees in the U.S. in the coming years, as its original content continues to grow in popularity. We now project the fee to increase to $12 by the end of our forecast period.

Growth In International Subscribers To Drive Valuation

According to Trefis estimates, the International Streaming businesses contributes over 40% of Netflix’s valuation. Trefis estimates that Netflix’s international subscribers will increase from around 44 million in 2016 to nearly 110 million by the end of our forecast period.

Apart from Europe and Latin America, Asia-Pacific will be a key driver of this growth. Netflix is planning to license its content in China for now, given the challenges of entering the market directly, but the company has been witnessing strong traction in India and several other Asia-Pacific markets.

Despite the aforementioned traction, emerging markets present challenges that the company did not have to deal with in developed markets such as the U.S. For one, many of these markets have inconsistent internet connections and low speeds. Further, some emerging economies are “Mobile First” markets where most video consumption happens on smartphones. High data charges on mobile phone plans can limit video consumption, and as a result these consumers prefer to download videos when a Wi-Fi connection is available and watch them later on the move. To mitigate this, Netflix launched an offline feature in late 2016 to entice mobile users. Additionally, the company is developing a slate of local original content for its international markets to lure customers. These developments, coupled with favorable secular trends, should help the company see strong growth in its international streaming subscriber base going forward.

Steady Improvement In International Margins To Boost Profitability

Netflix’s international streaming margins have improved steadily over the years, climbing from -127% in 2012 to -7% in 2016. However, the margins have been under pressure of late, largely due to unfavorable currency movements and the additional costs undertaken related to aggressive expansion. The company expects the international streaming contribution margin to be around -1.5% for the next three months. We believe that Netflix’s international segment could start to break even in 2017, and will have a positive – and steadily expanding – contribution margin in the coming years.

Another area in which Netflix has seen rapid improvement is the contribution margin for its domestic streaming segment. This margin has improved from 14.3% in 2011 to 38.2% in 2016. The company had earlier stated that it intends to improve its domestic streaming margin by 200 basis points per year, but now believes that it can improve even further as a larger portion of global and original content costs will now be absorbed by the company’s ever-growing international territories. The company intends to cross the 40% threshold by 2020, and we estimate that domestic streaming margins will exceed 43% by the end of our forecast period.

Focus On Content And Expansion To Escalate Costs

With so many players in this industry, content is likely to be the key differentiator. Netflix is focusing on original programming to develop a competitive edge, and has a long-term goal of ensuring that nearly 50% of the content streamed on its platform is original. The company plans to develop 1600 hours of original content in 2017 and has a budget close to $6 billion for the programming slate. We estimate that Technology & Development Costs (As % of Revenues) will increase from 8.82% to 10.08% by the end of our forecast period.

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