It is difficult to have any conversation about the online video streaming industry without the mention of Netflix, Inc. (NASDAQ:NFLX). In fact, Netflix is the clear leader in the U.S. Internet video streaming market. As of spring 2015, the company accounted for the majority of the North American download Internet traffic at 36%. It significantly dwarfed Hulu (1.9%), Amazon.com, Inc. (NASDAQ:NASDAQ:AMZN)’s Amazon Instant Video (2%) and all others in the online video space.
However, everything is not well with Netflix. The company’s expansion abroad presents both opportunities and challenges. Because Netflix is facing market saturation in the domestic market, the company is betting on expansion overseas for new growth, and there is promise, but the near-term will be challenging.
The speed bumps in view
Cash shortage looms:
As much as Netflix is netting millions of new subscribers abroad, the impact of the international expansion on the bottom-line will certainly take time to be felt. Yet, the company is almost running into a serious cash shortage situation that could cripple its global expansion.
Netflix currently sits on a $2.8 billion cash stockpile, which is offset by a $2.4 billion debt. That suggests limited flexibility in Netflix’s balance sheet, yet the company will continue to burn more cash as it targets to be present in 200 countries by 2017.
The looming cash deficit is a potentially dangerous speed bump to Netflix’s global expeditions. With the balance sheet already heavily leveraged, Netflix may be compelled to return to the equity market to raise more funds to finance its global expansion, but that will dilute value for the existing shareholders.
To avoid equity dilution, Netflix, Inc. (NASDAQ:NFLX)’s mature markets should be able to finance overseas expansions. However, Netflix is already facing margin pressure in the mature markets, such as the U.S. where competition is also getting intense almost each day.
Content challenge:
Most of the cash that Netflix is spending on global expansion goes into acquisition of content, which include original programming and marketing of the service. However, when it comes to content, Netflix will face the challenge of creating sought-after original shows such as the House of Cards, Orange is the New Black and others that have given it an edge in the U.S.
Any misstep in content creation for the select international markets can be costly and would set back the company in a huge way.
Threat of piracy:
There is risk that Netflix’s global expansion will also expose the company more to threats of content piracy. A thriving piracy market will certainly hurt Netflix in many ways, of course, until it finds a lasting solution.
The one awkward scenario that Netflix could find itself in is where content providers pile pressure on it to crack down on piracy, especially in global markets where the service has not launched. It was revealed that Netflix was already coming under pressure from Sony Corp (TOKYO:6758) to end piracy in Australia where people were using VPNs to avoid geological content restrictions before the service launched there.
Mounting pressure to clamp down copyright infringement could see the company channel some of its financial resources to fight piracy, thus further compounding its cash woes.
The other possible unfavorable situation in a thriving piracy market is that Netflix could be forced to offer its services at lower prices to avoid fueling backstreet trade on its content. If Netflix raises prices, some of its subscribers that currently pay for the service may be lured to pirated content with the promise of paying less. Without adequate room to raise prices, Netflix may not extract maximum value from its investments abroad.
Exposure to FX risks:
Besides the risks of cash shortage and piracy, expansion abroad also exposes Netflix, Inc. (NASDAQ:NFLX) to greater foreign exchange risks. The company currently generates most of its revenue in the domestic market, but in the future the management wants most of the revenue to come from abroad. Because the company is domiciled in the U.S. and reports in dollars, adverse currency movements can have material negative impact on its reported revenue.
Global expansion plan
The management is working to expand Netflix in at least 200 countries by the end of 2017. The service is currently available in 50 countries. Among the countries targeted for immediate expansion are Japan (third quarter 2015), Italy, Spain and Portugal, which are targeted for fourth quarter 2015 launch. China is also under consideration for a possible 2016 launch. But the management is taking a more cautious approach in China expansion.
Because Netflix is expanding into more non-English markets, the company has to invest more on content that is relevant for each market, and that is costly, at least in the short-term.
Why there is no cause for alarm
Netflix, Inc. (NASDAQ:NFLX) may be burning cash at a rapid rate through its international expansion, exposing it to a risk of cash shortage and lower margins overseas. However, Netflix is on a growth phase and most investor attention is on its subscriber growth trend with bottom-line results being almost inconsequential at this juncture. And when it comes to subscriber growth trend, Netflix is doing extremely well as the company’s international subscriber growth is more than 68%. Investment in new content and aggressive marketing are paying off for Netflix in its global expansion.
It is only after the global expansion is concluded that it makes sense to start questioning the management for the value of the investment. Because of that, current challenges can only be viewed as passing clouds with the real benefits only delayed but not denied.
Revenue source
Netflix’s revenue comes from monthly subscription fees. The company charges $8 per month for its Internet-based video streaming service. The company has 68 million global subscribers. The fact that Netflix currently relies on subscription fees for revenue suggests that the platform has more room for further monetization. Although the management is not saying it, Netflix could also serve ads against its content to generate incremental revenue.
Netflix’s categories
Netflix, Inc. (NASDAQ:NFLX) operates in three categories, namely DVD subscription, domestic streaming and international streaming. DVD subscription is Netflix’s old business segment.
The company generates 10% of its revenue from DVD subscription and 28% from international streaming. Domestic streaming is the largest revenue contributor at 62%. However, the management is working to generate only 40% of total revenue from the domestic market in the future.
Bottom line
There are speed bumps in Netflix, Inc. (NASDAQ:NFLX)’s pursuit of meaningful growth, but they should be short-lived as the company has a much brighter future.
Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.