Recent second-quarter results from Netflix (NFLX, Financial) were mixed. They showed a 40% increase in revenue to $3.91 billion, which was slightly below market expectations of $3.94 billion.
New subscriber numbers also failed to meet consensus forecasts. The company added 5.2 million new subscribers. Expectations were for 6.2 million.
Global streaming revenue increased 43% from the prior-year quarter. A 14% increase in the average selling price per member provided a boost to its financial performance. Earnings per share of 85 cents were significantly ahead of guidance of 79 cents.
In the third quarter, the company is aiming for 5 million net new subscribers. It continues to expect negative free cash flow of between $3 billion and $4 billion for the full year as it invests in new content.
International prospects
Since the release of its quarterly results in July, Netflix shares have fallen 15%. Its valuation is still up by 103% over the last year, though, which is ahead of the S&P 500’s 17% rise over the same period.Â
International growth could have a significant impact on Netflix’s financial performance and stock price over the medium term. It has become increasingly focused on producing international content in recent quarters, potentially offering a more localized experience for consumers. The company has also succeeded at exporting local content on a global basis, with shows such as "The Rain" and "Dark" proving to be popular outside of their domestic markets. As the company adds more local content and translates more of its shows into other languages, its international growth rate could increase.
The company has a particularly strong growth outlook in emerging markets. It recently announced a change in strategy in terms of how it will approach growing demand for streaming services in the developing world at a time when wage growth continues to be strong. In India, for example, it is testing new pricing models in order to accomodate different demographics within the market. This will allow it to not only retain its premium subscribers, but also attract consumers who may prefer a lower-cost option until disposable incomes rise. A tiered pricing system could help the company grab market share across the emerging markets and may catalyze its financial performance in the long run.
Growth opportunity
Netflix’s stock price may be catalyzed by a diversification of its content strategy. It has enjoyed considerable success in the original TV series format in recent years and is now seeking to differentiate itself from rivals through new content in areas such as unscripted shows, anime shows and original movies. This could help widen its economic moat even further, with an $8 billion content budget for 2018 having the potential to provide it with a competitive advantage over rivals.
A wider variety of unique content may also help to quicken the pace at which consumers dump cable for streaming services. In 2018, the number of consumers cancelling their pay-TV subscriptions is expected to increase by 33% even though several cable companies are now offering streaming as part of their content packages.
Competition
One potential threat for Netflix over the long term is Disney’s (DIS, Financial) entrance into the streaming services marketplace in 2019. Not only will the company lose Disney content, but it will also have to compete with the company following its acquisition of Twenty-First Century Fox (FOXA, Financial). The entertainment company will also be able to aggressively compete on price as it has a lower volume of content that is largely geared toward families. Â
While Disney is a threat to Netflix’s long-term outlook, it has gradually been reducing its reliance on the company's content in recent years. Its significant investment in original content helps it combat the risk of competitors taking back their content to create their own streaming services. With U.S. households subscribing to an average of three streaming services, there may be room for Netflix and Disney within what is likely to remain an oligopolistic market structure due to high barriers to entry.
Verdict
The international growth potential for Netflix remains high. With a tiered pricing structure having the potential to boost its performance, the company could deliver particularly strong growth in emerging markets. Further investment in a more diverse range of content may boost subscriber numbers, while the trend of cable subscribers moving to streaming services looks set to continue. Although Disney's entrance into the streaming services market is a potential threat, there could be room for both companies to grow. Therefore, after high stock price appreciation over the last year, there could be further gains ahead for Netflix.
