Why Netflix Needs Europe

Netflix is flying in the stars of 'Orange is the New Black' to celebrate its European roll out
Netflix

The streaming video giant launched in France Monday, the first of six new European markets this week

The European revolution will not be televised, but it will be available online.

Netflix launched in France on Monday, with services rolling out in Germany and four other European countries in the coming days, bringing the streaming video service that has forever altered American viewing habits to potentially millions of new European consumers.

"We are proud to bring the future of television to France," said Netflix CEO Reed Hastings in a statement released before sunrise Paris time. "French viewers will have instant access to a multitude of movies and series, where and when they wish."

Netflix is pulling out all the stops for its European bash, holding rolling red carpet galas across the continent this week, starting Monday in Paris and moving to Berlin on Tuesday.

CEO Hastings will be playing host, alongside stars from top Netflix' shows including Orange Is the New Black's Taylor Schilling, Laura Prepon and Uzo Aduba; Hemlock Grove executive producer Eli Roth and series star Famke Janssen; and DJ Cotrona and Zane Holtz of From Dusk Till Dawn.

Noticeably absent will be the stars of Netflix' House of Cards. The hit political drama airs on competing European networks: CanalPlus in France and Sky Deutschland in German-speaking Europe.

Launching in six countries in one week – including two of the world's biggest TV markets with France and Germany – is a bold move for Netflix. How well the streaming video group succeeds in establishing binge viewing in continental Europe could be a major factor in determining the company's overall fate.

In an interview with the Financial Times, Hastings called this week's European expansion "the biggest international launch we’ve ever done."

Interestingly, Netflix is not going it alone in Europe. In France, Boygues Telecom will offer Netflix over its set-top boxes come November, making the service available on demand over TV sets. In Germany, the company is partnering with the country's leading Internet Service Provider Deutsche Telekom.

But the company also faces stiff resistance. In France telecommunications operators such as Orange have refused to carry the service on their popular Internet-connected TV set-top devices because they have been unable to agree on financial terms.

The continent’s film producers have complained the company is paying a fraction of the normal fee for rights to European movies and is avoiding contributing to France's film subsidy system by setting up in Amsterdam, where it is not liable to pay the French tax that bankrolls national cinema and public broadcasting.

To demonstrate its commitment to French production, Netflix has announced it is financing a Mediterranean-set political drama, Marseille, which promises to be a Gallic House of Cards. The show is set to launch in late 2014. Netflix also picked up popular French animated series Wafku last week just ahead of its launch and will complement its largely US series offerings with local hits like Un Village Francais.

Netflix' European roll out has already set competitors scrambling. In France last week, pay-TV group CanalPlus announced new Netflix-like features to its online service, including a suggestion engine based on previous choices, and it has bulked up its program offerings, acquiring local TV comedy production house Studio Bagel and signing a deal with HBO for rights to older series. 21st Century Fox's Sky Deutschland launched a SVoD service in Germany in anticipation of Netflix and broadcast competitors RTL and ProSiebenSat.1 have all pumped up their online services to ward off the expected onslaught.

For Netflix itself, Europe is about keeping its subscriber growth going. International operations have been driving subscriber growth at Netflix for years. This latest launch across six European territories gives the group access to a potentially massive market of 60 million broadband households. In a letter to shareholders this summer, Hastings and Netflix CFO David Wells said the Euro roll out will “significantly increase our European presence and raise our current international addressable market to over 180 million broadband households, or two times the number of current U.S. broadband households.”

So far, Netflix' timetable has seen it launch in a new international region roughly once a year. Its first foreign foray was to Canada in 2010, followed a year later by Latin America. In 2012, the company brought its service to the U.K. and Ireland, as well as Scandinavia. Last year, Netflix introduced its streaming services in the Netherlands. This week it will hit six European countries in one go (following France and Germany, Netflix will start operations in Switzerland, Austria, Belgium and Luxembourg).

Given the regular cadence of past launches, some on Wall Street predict further international expansion late in 2015.

"We also assume new markets, Spain and Italy, will be targeted for a fourth-quarter 2015 launch, which both pushes our subscriber forecasts above the [Wall] Street [consensus], but knocks international profitability well below," said MoffettNathanson analyst Michael Nathanson.

As of mid-year, Netflix had more than 50 million total subscribers, including 12.9 million paying and 13.8 million total subscribers outside the US. Revenue for its U.S. business amounted to $838 million in the second quarter, up 24.9 percent from $671 million. International revenue rose 84.9 percent over the same period to $307 million. Subscriber growth over the past year reached 6.40 million in the U.S. and 6.05 million internationally.

No wonder then that industry watchers say further international market launches will be a key growth driver for the company in the years ahead. But many predict the investment in international expansion will mean continued losses for Netflix's international business.

Excluding the latest European launches, the company's international business is on track to be profitable by the fourth quarter, management has said.

"Europe Gives, and Europe Takes," Morgan Stanley analyst Benjamin Swinburne said in the title of a new report on Monday to highlight the mixture of good news and bad news tied to the new launches. "We raise our international sub forecast for the fourth quarter and beyond, reflecting expectations for a stronger ramp in the six new markets launching this week," he wrote. "Based on third-quarter guidance for paid versus total subs, we estimate new markets contribute 1 million of non-paid net adds during the last two weeks of September alone."

As Netflix's U.S. business has reached a level of predictability, Nathanson that "international subscriber growth is the most important variable driving stock performance for the foreseeable future." He estimates that the company can reach around 7.9 million incremental subscribers in the new markets mid-term.

"We now project Netflix international paid subscribers will nearly reach 46 million in 2018 with the most amount of subscribers in Latin America, followed by Canada, U.K. & Ireland and the Nordics," he said.

Nathanson's year-end 2014 estimate is for 4 million subscribers in Canada, 3.6 million in Latin America, with U.K. and Ireland reaching 3.5 million and the Nordics 3.4 million. Out of the new markets, he projects Germany to have the most users by year-end with 700,000, followed by France with 600,000, and Belgium, Switzerland and Austria with 100,000 each. By end of 2016, Germany will have 3.3 million Netflix users, France 2.7 million, Switzerland and Belgium 400,000 each, and Austria 200,000, with Luxembourg not reaching a big number due to its small population, according to Nathanson.

For the company's financials, this will mean declining international losses. "In 2013, Netflix's international business represented 21 percent of streaming revenue and losses of $274 million," Nathanson said. "We project improving profitability from Netflix's international subscriber base from existing territories will continue to be offset by the new launches over the next couple of years leading to further, yet improving, international streaming contribution losses."

He expects an international loss of $193 million this year, $166 million in 2015 and around break-even in the following two years, followed by a $215 million international profit in 2018 when Nathanson expects Netflix will have 45.8 million international subscribers.

What do the latest launches mean for the stock price? "We think that Netflix's stock will continue to outperform over the next month as the Street has to revise up near-term international subscriber estimates," Nathanson said. "In the medium term, we think the Street will likely take a closer look at international losses, which could neutralize the stock's momentum."

Said Swinburne: "We would be buyers on weakness as our international subscriber analysis leads us to believe that the company is scaling overseas."

While Wall Street is discussing the expansion's financial impact, Netflix' focus in Europe this week is on reaching, and entertaining, a new audience.  On its main Twitter feed on Monday, the company celebrated the move into France with the message "Bon voyage, @NetflixFR".

We'll see what sort of welcome European users give them back.

Rhonda Richford in Paris contributed to this report.

Twitter: @georgszalai

Twitter: @sroxborough

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