Netflix’s international operations are expanding faster
Earlier in this series, we’ve discussed Netflix’s (NFLX) prospects in the U.S. market. But international markets have started to become more valuable for Netflix. The number of net subscribers additions in the international markets has increased from 1.44 million in 3Q13 to 2.04 million in 3Q14. As the chart below shows, Netflix expects 2.15 million net subscriber additions in the fourth quarter. This growth is faster than what Netflix experienced in the U.S.
Netflix continues to invest heavily in international markets
Netflix started its international operations in Canada four years back and now provides its service to 40 countries. In the third quarter, Netflix launched in six additional countries, including France and Germany. The company mentioned that about 80% to 85% of the overall content in European countries is Hollywood or other international content, and the rest is local content customized for each country.
During the conference call to announce earnings, Netflix management mentioned that Time Warner (TWX) has been aggressive in marketing its HBO Go service in Nordic countries, but Netflix service is still well ahead of HBO Go. In Canada, Netflix struck a multi-year licensing deal with Walt Disney (DIS) for providing exclusive content for consumers to watch online.
Investments in international markets impacting margins
Although Netflix continues to acquire more international markets and more subscribers, the upfront investment associated with each new country means the company’s margins are declining. The operating margin for Netflix’s international division was -9% last quarter. The company expects this margin to further decline to -25% in the fourth quarter.
There’s another reason why expansion in Europe should affect Netflix’s margins. According to a change in European law, Netflix will pay higher value-added tax (or VAT) to the European government starting next year. Netflix plans to absorb these costs and not pass them on to its customers, which is why its margins will decline.
However, Netflix still considers international markets a big opportunity. It plans to invest most of its profits in these markets for future growth. Growth in international markets should benefit exchange -traded funds (or ETFs) such as the DJ Internet Index Fund (FDN) and the NASDAQ Internet Portfolio (PNQI), which have high exposure to Netflix.