Analysts Put Spotlight on Netflix's International Expansion Costs, Benefits

10:04 AM PST 07/22/2014 by Georg Szalai

Subscriber growth outside the U.S. was ahead of expectations in the latest quarter, but one Wall Street observer says the planned rollout in six new European markets "appears costlier than anticipated."

Netflix's second-quarter earnings report had much information to digest for Wall Street observers beyond the fact that the company crossed the 50-million-subscriber mark globally.

The outlook for the streaming giant's international business attracted particular attention ‎from analysts on Tuesday.

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"‎While domestic streaming subscribers were in line at 35.09 million, international exceeded expectations at 12.91 million," said Credit Suisse analyst Stephen Ju in a report.

Netflix management credited the international user growth on consistent subscriber additions, highlighting that even growth in Brazil continued at a good pace during the World Cup.

As widely expected, Netflix on Monday confirmed the planned September launches in Germany, France, Austria, Switzerland, Belgium and Luxembourg. 

Ju raised his target price on Netflix's stock from $369 to $430 "as we increase the growth trajectory of Netflix’s international subscriber base." He added that while he reduced his 2014 and 2015 earnings estimates "as we ramp content costs for the French and German markets," he increased his 2016 estimates citing "the ultimately higher subscriber base."

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Concluded Ju: "As we have noted before, this is a playbook Netflix has already executed in other Western European as well as Latin American markets, and this should ultimately lead to margin expansion ... as the subscriber base in the newly launched markets scale beyond this period of investment." He maintained his "neutral" rating on Netflix's stock.

Evercore Partners analyst Alan Gould also lowered his 2014 and 2015 earnings forecasts "due to the international expansion."

He also wrote: "Third-quarter international losses will mount due to the additional content and marketing expense required to increase the international footprint by roughly 60 percent in September."

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He predicted possible Asia launches in 2016 at a time when Australian media have already suggested a possible Netflix launch down under next year.

Janney Montgomery Scott analyst Tony Wible on Tuesday was particularly bearish on the near-time earnings effects of the six new market launches, saying the plan "appears costlier than anticipated based on guidance."

He explained: "International and original programing investments are weighing on earnings and free cash flow."

While "recently launched markets are ramping to profitability faster than expected," projected third-quarter losses "are greater than expected, implying that launch costs for new markets are significantly higher than our prior estimates," Wible said. "This is likely driven by the size of the new countries — France and Germany — and the market-specific initiatives. This lowers near-term estimates but should accelerate sub growth."

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Cowen & Co. analyst John Blackledge said that Netflix's international subscriber growth guidance for the current third quarter of 2.36 million was "well ahead of our prior 1.1 million estimate and consensus of 1.5 million given higher expectations for expansion and better international uptake." While he acknowledged the costs, he also raised his price target from $355 to $415.

Nomura analyst Anthony DiClemente used a reference to Netflix original series Orange Is the New Black in the title of his report in highlighting how key the international expansion was for observers and updates to his financial models — "International Is the New Domestic." 

The higher near-term costs for the international market launches seemed to be among the factors that weighed on Netflix's stock on Tuesday. As of 1 p.m. ET, it was down 5.5 percent at $427.10.

Email: Georg.Szalai@THR.com
Twitter: @georgszalai

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