Why is Netflix Struggling Overseas?

Reed Hastings - H 2015
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Reed Hastings - H 2015

The streaming giant faces stiff competition, a recalcitrant China and a hard-to-please foreign audience in its bid for global domination.

Netflix kicked off this year with a massive international roll-out. In January, Reed Hastings announced the company had tripled the number of countries where it's available, bringing the total to 190. With the (major) exception of China, Netflix truly is everywhere.

So how to explain Netflix's quarterly figures, released Monday, which showed international subscriber growth slowing, with just 1.5 million new Netflix customers added outside the U.S.? Netflix's own forecast for the third quarter calls for 2 million new international additions, or 25 percent fewer than it added over the same period in 2015.

“The deceleration internationally was the biggest surprise,” wrote MoffettNathanson analyst Michael Nathanson. “How does a company grow net subscribers more slowly against an expanded total addressable market?”

It's a question Netflix analysts (and the company's competitors) are obsessing over.

It's no secret Netflix needs global growth if it is to hit its ambitious targets and the streaming giant has made major inroads in several territories —particularly in English-speaking world and in Latin America. Elsewhere, however, the company has faced major headwinds as it tries to conquer the world.

The three major challenges can be broken down this way: content, price point and competition.


While CEO Reed Hastings likes to portray Netflix as a global monolith —indeed the company does not break out subscriber figures in individual international territories — Netflix in Europe or Asia is not the same as Netflix U.S.. Internationally, Netflix has far less content. The company is bulking up on global licensing deals —this week they announced a major agreement with CBS to take the network's upcoming Star Trek series reboot, as well as all 727 existing episodes of the iconic Star Trek television library in 188 countries outside the U.S. and Canada—but ramping up will take time and existing licensing deals, some with local competitors to Netflix, will slow the process.

“We believe that Netflix's international content may be too thin to attract enough gross subscriber additions to hit its targets and insufficiently robust to retain as many customers as the company has modeled,” warns Wedbush Securities analyst Michael Pachter.

And foreign audiences want both more and different content. So far, Netflix has focused mainly on English-language films and series, with an 80/20 model of U.S. vs. local content in most territories. It has focused much of its local investment on marquee original productions — with foreign-language series such as Columbian crime drama Narcos, French political thriller Marseilles or Hibana (Spark), a series set in the world of Japanese stand-up. The bulk of its content, however, is in English, something that, in many territories, limits Netflix' audience appeal.

Aravind Venugopal, vice president at Singapore-based Media Partners says across most of Asia, offering just English-language content means Netflix is “skimming the very cream of the market – maybe the top 1 percent. Even in territories where many understand English, like India, consumption of English-language content is not high.”

Netflix is addressing this problem, to a degree. It's announced plans to introduce dubbing and subtitling in Poland and Turkey and is tilting more towards local content in countries like Japan.


But localizing can be expensive, adding to Netflix' already massive content budget, set at $6 billion for this year alone. Cannacord Genuity analyst Michael Graham doesn't see that as a major problem, noting that in all markets where launched before 2014, including Canada, Latin America, the U.K., and the Nordics, operations are profitable. He expects those territories to generate $500 million in contribution profits this year, money that can help pay for start-up costs elsewhere. "However, we still expect overall international contribution profit to be a loss in 2016 as profits in early markets are used to improve, localize and build other international regions," said Graham.

Netflix could turn to price hikes to help offset those costs —as it has in the U.S., where it has bumped up the monthly cost of its most popular service from $7.99 to $9.99. Netflix blamed the increase, or rather media reports of same, for increased “churn” this past quarter, as subscribers signed up under the older, cheaper plan cancelled rather than pay the higher monthly fee.

In many parts of the world, however, Netflix is already, arguably, too expensive. In most Asian markets, notes Venugopal, Netflix is among the most expensive SVOD offerings and often as or more expensive than existing pay-TV services. Local operations like Malaysian-based IFlix, which earlier this year got a $45 million investment from European pay-TV group Sky; or Hooq, a joint venture between Sony Pictures Entertainment, Warner Bros. and Singapore-based telecoms company SingTel, are priced in the $2-$4 range, compared to $9-$10 for Netflix.

“Except for maybe the top 1 percent in many territories that's just too expensive,” says Venugopal. Unless Netflix introduces variable pricing, charging less for its service in certain countries, something the company has so far refused to do, he believes they will stay “in third or fourth place among SVOD players in most territories.”


In richer nations, Netflix's main challenge comes from local competition, often entrenched national broadcasters with deep pockets. Canada's Bell Media, for example, outbid Netflix Canada on the Star Trek deal, carving out local rights its network and SVOD platform. In Europe, Sky, a pay TV giant partially in which Rupert Murdoch's 21st Century Fox owns a 39 percent stake, is a major buyer, and producer, of the kind of binge-worthy TV Netflix specializes in. Ian Whittaker, an analyst with London-based Liberum Capital, noted that Netflix's weaker-than-expected quarterly results this week should “bode well” for Sky.

“Also, pay TV operators that are threatened by the cheaper SVOD alternative Netflix should be relieved on the back of these results,” he wrote in a report to investors. .

Amazon Prime's streaming service is also a major Netflix competitor, at least in select European markets. In Germany, Amazon is actually ahead of Netflix. Andre Wiegand, managing director of Cologne-based analytics group Goldmedia, cites the company's own research that shows Amazon currently accounts for 32 percent of the German SVOD market, compared to 17 percent for Netflix. Sky's streaming offer is third, with a 12 percent share of the German market.

“But our figures show VOD use has more than doubled in Germany since 2014,” noted Wiegand. “Netflix only launched here two years ago, so we expect them to build their subscriber base as the market grows. But by how many users depends on how new players pushing into the market, like YouTub Red or Disney Life, position themselves.”

Adds Whittaker: "with Amazon Prime suggesting its entry into more European markets before year-end, [that] implies a not so rosy outlook for Netflix.”

But not all rich media companies are willing, or able, to go toe-to-toe with Netflix. On Friday, French giant Vivendi announced it was shutting down its German SVOD service Watchever, which launched first in the German market but quickly lost ground once Netflix arrived.


Then there's China. The world's largest Internet market, with some 649 million users, China remains a very big dark spot on Netflix's international growth plan.

Hastings has expressed interest in entering China since at least 2015, but the company has been stymied by Beijing's strict regulatory regime and penchant for keeping powerful foreign rivals out so local services can thrive. In the first half of 2016, the Netflix's odds in China have only grown longer.

"Unfortunately, this year the regulatory climate in China for our service has become more challenging," Netflix said in its quarterly letter to investors. 

Indeed, the harsh stance China's regulators have taken recently towards imported digital services doesn't augur well for a Netflix launch anytime soon. In April, Apple's iMovie and iBooks services abruptly were forced to shut down in China. Days later, regulators pressured Alibaba to suspend service of DisneyLife, an OTT service that it was using to distribute licensed Disney content in China. Neither service has yet to be restored.


Six months after going truly global, Netflix has hit its first speed bump. Other factions, including this summer's Olympics, also don't bode well for international growth in the short term. The company's early success —in Canada, Latin America, and the U.K., for example —“could take longer than expected” to replicate worldwide, concludes analyst Nathanson.

The established territories are likely to remain Netflix's biggest markets for the near future. Morgan Stanley analyst Benjamin Swinburne expects the company to end 2016 with 41.74 million international subscribers, of which more than 13 million will be in Latin America, 8.8 million in the U.K. and Ireland and 3.5 million in Scandinavia. But Swinburne expects several newer territories to top the 1 million subscriber mark this year, including Germany, France, Japan and the combined Southern European territories of Italy, Spain and Portugal.

Even given the recent slowdown, Swinburne predicts international subscriber figures will overtake Netflix' U.S. subs by next year,
In Asia, Venugopal of Media Partners is also cautiously bullish about Netflix' future, particularly if the company can sign local deals similar to its Comcast agreement in the U.S., allowing the service to get onto traditional cable and boost its audience reach.

“Internationally, you can't expect them to go from zero to 100 in a year,” said Venugopal. “The hammering of Netflix this week because of one poor quarter is a bit overdone. If by the second quarter next year if things haven't changed OK, but, in this region at least, this is a very new company and these kind of bumps are to be expected.”