Chantal Marx & Nick Crail
Netflix was founded by Marc Randolph and Reed Hastings in 1997, as the first DVD rental and sales website in the United States (US), and globally at the time. In 2007, the company launched a streaming media service, introducing video on demand via the Internet.
Since its streaming launch, the company has navigated several challenges - in the mid-2010s it was essentially forced into investing substantial cash in building and scaling its own global studio as it became evident that several traditional media companies and studios would begin limiting content offered to Netflix. From 2019, several of these traditional media companies and studios launched their own streaming services, essentially disrupting competitive dynamics in the streaming market. Finally, the pandemic and post-pandemic normalisation had a meaningful impact on the industry and the business specifically.
We have now entered a period of relative stability in the market, and Netflix has emerged as the clear leader in the internet streaming space, with strong competitive advantages, and importantly, significant scale.
Netflix has a presence in over 190 markets and boasted over 280 million subscribers as at 3Q24. The US and Canada is its largest market, and this is expected to remain the case for some time.
The addressable market is still large
The addressable market for streaming remains compelling, and Netflix's global leadership and content budget remain key advantages in capturing share of overall market growth.
In terms of the number of users, it is projected that the streaming video on demand (SVoD) market will have 1.7 billion users in 2027, up from 1.3 billion users in 2023, representing a compounded annual growth rate of just under 7% per year. Even in this scenario, the user penetration rate, which measures the proportion of the population using video streaming services, is expected to grow from 17% in 2023 to 20.7% in 2027. This means there is still scope for expansion beyond the next few years.
The emerging markets opportunity is there, but there is still scope for growth within developed markets as well where ability and willingness to pay for content is higher. In the US and Canada, user penetration is close to 50% and in other developed markets, penetration is hovering at between 10% and 40%, depending on the market.
As such, the expectation is that Netflix will be able to continue growing subscribers, which together with a slight uptick in revenue per customer going forward, will underpin sustained revenue growth.
Competition's shift in focus and a deepening competitive moat
Netflix competitors include other streaming platforms but also short video format platforms like YouTube, TikTok and other social media providers. Most of the streaming providers have indicated in recent times that they will move their focus away from a primary focus on subscriber additions and instead direct energy towards improving profitability and cash flows. This means that content expenditure could be strained, particularly original content production - favouring Netflix that has substantial scale and a longer track record in producing original content.
Netflix's owned originals are its most popular and most watched content and provides a key competitive advantage for the business. In the first half of 2024, among its top 150 titles, 61% of viewing hours were ascribed to original content.
Additionally, the company has invested in international foreign language programming - which means that subscribers in specific countries can view "local" content on the platform. Some of these titles, like Squid Games (Korean), Money Heist (Spanish) and Lupin (French) have enjoyed significant crossover appeal in English-speaking markets as well.
Ad tier introduction
While the start to Netflix's advertising lower cost subscription offer was initially slower than expected, we think that this could help broaden the subscriber base and diversify its revenue streams. The expectation is that this offer should generate about 2.5% to 3% of revenue this year.
Despite the challenges faced so far, there is scope for this contribution to expand and the expectation is that revenue per subscriber will come close to the standard offering longer term. Netflix has kept pricing low for its ad-tier offer and is currently pricing in the middle of similar competitor offerings - with arguably a better content library. We think that this offer could also help spur growth in middle- and lower-income markets as it is rolled out there.
Investment case summary
Risks
How is content accounted for?
Netflix capitalises almost all licenced or produced content cost and then amortises that cost over the "useful life" of the content - usually ten years. This means that the cost of buying third party content or developing its own original content is carried on the balance sheet and introduced to the income statement in smaller increments.
All titles in the content library are amortised on an accelerated basis. On average, over 90% of a licensed or produced streaming content asset is expected to be amortised within four years after its launch.
First run topical programming like talk shows are expensed upon airing.
The impact on the cash flow statement of buying or producing content is immediate. This means that the company could see a cash flow impact of a new production years before the release, and that the cash flow impact of purchased content is initially much greater than the income statement expense.
Consensus considerations
Outlook & valuation
