Netflix Inc. (NFLX) recently signed a new multi-year licensing agreement with Hollywood studio Metro-Goldwyn-Mayer Studios Inc (MGM). Under the terms of the agreement, Netflix will obtain the license to exclusively stream movies produced by MGM in the United Kingdom and Ireland.
Earlier, Netflix had announced its intentions to enter the United Kingdom and Ireland by early 2012. Netflix subscribers in these regions will be able to watch popular MGM movies, such as “The Hobbit: An Unexpected Journey" and "The Hobbit: There and Back Again”, "Zookeeper", "Hansel & Gretel: Witch Hunters," and "21 Jump Street," within the first year of their theatrical release by paying a monthly fee. Moreover, MGM’s vast catalogue of movies will also be available for the United Kingdom and Ireland subscribers.
Netflix has been consistently pursuing international expansion to boost its top-line and earnings growth over the long term. As a part of its expansion strategy, the company launched operations in 43 Latin American countries and in the Caribbean region in September this year.
However, entry into the United Kingdom is particularly significant due to the country’s very high level of Internet penetration (approximately 77.0% of households) and access to broadband Internet or video game consoles compared to the Latin American and Caribbean regions. Moreover, the number of persons using debit and credit cards is also high in comparison to Latin America.
We believe the partnership with a renowned studio such as MGM will help Netflix expand further into new territories. The company has been active in signing licenses and has been partnering with several big Hollywood production houses, such as Paramount Pictures, Twentieth Century Fox, Disney-ABC Television Group, DreamWorks Animation and Miramax studios, for new content additions.
We believe that these content additions will enable Netflix to reduce its dependence on cable TV operators and also provide the necessary competitive edge over its peers in the emerging market of online video streaming. Netflix expects to remain profitable on a global basis for the fourth quarter of 2011, primarily based on the new content additions, which will have a positive impact on existing subscribers in the domestic market and add new subscribers to its international ventures.
However, expansion in the United Kingdom and Ireland are expected to hurt Netflix’s margins in the near term. Netflix expects its margins to remain subdued due to brand-building initiatives and other costs in the forthcoming first quarter of 2012.
Our Take
We believe Netflix’s continuous focus on overseas ventures and content additions, cost escalation in the form of license and renewal fees, as well as necessary technology investments would be headwinds going forward.
Additionally, intensifying competition from large players such as Amazon.com Inc. (AMZN), Apple Inc. (AAPL) and Google Inc. (GOOG) in the online streaming market is also a headwind, as it will further escalate license fees and also affect subscriber additions over the long term.
We also believe Netflix’s decision of raising DVD rental prices have not gone well with subscribers and a substantial decrease in subscriber base (800k during the third quarter) is expected to hurt top-line growth in the upcoming quarters.
We also believe Netflix’s initial decision of splitting its operations into two halves and subsequent backtracking has created a lot of confusion for domestic customers, thereby increasing chances of further declines in the subscriber base. Whether a significant growth in the international subscriber base compensates for this negative domestic trend is something to be watched for in the upcoming quarters, in our view.
We have an Underperform recommendation on Netflix over the long term (6-12 months). Currently Netflix has a Zacks #3 Rank, which implies a Hold rating in the short term.
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