Netflix, Inc. ($NFLX) revenue and stock price are driven by subscriptions
The key is to conquer the biggest markets: China and India
The option of advertisements could add a new revenue stream
Netflix recently announced its second quarter results. Though the company missed revenue estimates, better than expected earnings per share and subscriber growth drove the stock price. Netflix’s stock price history shows us the power of new media. More and more people are moving to the Internet for consumption of news and entertainment, as well as to purchase goods. Parallels can be seen in social media, where Facebook, Inc. ($FB) is used by an increasing number of younger adults for the consumption of news, bypassing the traditional sources of news dissemination. Netflix could bring a similar change in entertainment consumption, where customers have greater options and easier access to the content they like.
Driven by Subscription
Netflix’s stock price has closely followed the ability of the company to gain subscribers. The company’s revenue model is one of the simplest among its peers. The total revenue for the firm is equal to the number of subscribers, multiplied by the price of subscriptions. In order to increase its revenue, it would either have to increase its subscribers or increase the price per subscriber. Chicago recently announced a 9% cloud tax on streaming services, and Netflix will be incorporating this tax into their subscription fee. However, the main driver for growth can come from subscriber growth alone: the current figure for the firm stands at 65 million, but the biggest growth driver for the stock will come from global expansion, especially into markets like China and India.
Fig 1: Netflix subscriber growth in the past three years. Further growth seems certain on the back of global expansion. (Data: Netflix)
Therefore, the main driver in the minds of analysts and investors alike would be the extent to which subscriber growth can be achieved. The current figure for the firm stands at 60 million, but the biggest growth driver for the stock would be global expansion.
Conquering China and India
These two markets are, by far, the biggest markets for any firm. The ability to gain meaningful subscriber bases in these two markets could be one of the biggest factors impacting the stock’s movement in the future. According to Internet live stats, China, with 642 million and India with 243 million Internet users (Just behind 280 million in the US) can easily unfold the next subscriber growth story for Netflix.
Fig 2: Internet penetration in the US, China and India. The US has Internet penetration of close to 85%, whereas China and India are at 45% and 15% respectively allowing much room for growth.
China poses its own unique difficulties. Although the market of Internet users is much more mature, Chinese tastes for Internet content differ significantly when compared to its western counterparts. Behemoths like Amazon.com, Inc. ($AMZN) have not been able to gain a strong foothold in this market, even after spending huge sums of money. Local firms, on the other hand, are much more attuned to customer expectations. There are additional issues of getting the requisite licenses required to operate any Internet-TV from Beijing. Currently, only seven firms have secured this license, and if Netflix partners with anyone, it would cut into its revenue.
However, the Chinese government wants to ensure that 400 million households have broadband connections by 2020. Getting even 10% market penetration would provide a big boost to Netflix’s subscriber numbers.
On the other hand, India does not have the requisite infrastructure to support services for mass market. Fixed wireline connections form a minuscule percentage of the total Internet user base. The current growth in Internet users has been driven by smartphone users, for which the Internet price is still quite high for users to be streaming large amounts of video content. However, the market is abuzz with the pending launch of Reliance Jio, started by one of the most valued Indian firms, which claims that it will slash the cost of Internet connectivity by 50-80%.
Another major issue within India and China is that many in the region are not accustomed to paying for media content. Moving the customers to a subscription-based model would require correct pricing and good infrastructure support.
Netflix stock price history shows the positive impact of international subscription on the stock, and acquiring a good base in both these markets can provide the numbers Netflix is looking for.
Netflix stock price history by Amigobulls
The Advertisements Option
One has to look beyond subscribers and pricing to gauge the real value of Netflix. According to data provided by Netflix, subscribers streamed 10 billion hours of video in the first quarter, which translates to over 50 hours per subscriber, per month. These numbers are huge, and would be encouraging for any marketer. Although Netflix’s CEO categorically mentioned that there would be no advertising in the foreseeable future, it would be inescapable for Netflix to look at this revenue stream to fund its global expansion and increase its earnings.
Taking an optimistic figure of 200 million subscribers, which it might reach in another four to five years at an average price of $10 per month, translates to an annual revenue of around $25 billion. This industry has an average P/S ratio of 2.9x. For Netflix, this ratio might be a bit higher and reach 4x, giving it a $100 billion valuation based on subscribers. However, the biggest boost to the stock is possible only through advertising. This would require a good deal of finesse and PR with existing customers. The firm would certainly like to prevent the fiasco it saw in 2011 when it separated its DVD rental business.
Fig 3: Prediction of TV advertising revenue within the US alone. Online media like YouTube are getting an increasing share of the advertising pie, totalling $4 billion in the latest fiscal year.
Customers should be willing to accept reasonable advertising if it keeps the price of subscription to a minimum and also does not interfere with their viewing experience. The firm is already providing self-promotions in the beginning of a program similar to HBO. Currently, YouTube is streaming around 20 billion hours per quarter, which is twice as much as Netflix. Its standalone valuation is estimated at $40 billion. If Netflix’s subscribers grow to 200 million, the hours streamed can increase to at least 30 billion per quarter. These numbers alone should provide a possible upside of $60 billion in valuation for Netflix.
Again, the entire job would require good PR, slow roll-outs of advertising, and premium subscriptions with no advertisements if they’re going to prevent any customer disapproval.
The Outlook for Netflix
Netflix stock shows good momentum this year, with over 80% increase in price. The firm is currently valued at $40 billion, but there are huge upsides in the number of subscribers it can have, and the revenue it can get through advertisements.
About the author - Rohit Chhatwal is a contributor at Amigobulls. The views expressed in this article. This information is the writer's opinion about the companies mentioned in the article. Investors should conduct their due diligence and consult with a registered financial adviser before making any investment decision.
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