Netflix Puts Global Expansion On Hold As Costs Drag It Down

Netflix (NSDQ: NFLX) is on the road to profitability in Canada, but costs for its global roll-out are set to turn the company loss-making next year. So, after its next launches in the new year, Netflix will freeze international expansion.

“For a few quarters starting in Q1, we expect the costs of our entry into the UK and Ireland will push us to be unprofitable on a global basis,” the company told investors upon Monday’s Q3 earnings disclosure.

“After launching the UK and Ireland, we will pause on opening new international markets until we return to global profitability. We plan to do that by increasing our global streaming subscriber base faster than we increase our costs.”

The coming connected TV boom means an enticing global opportunity for Netflix – launching straight to TV, skipping DVD.

But, for some investors spooked by its recent indecision over its domestic model and by the loss of 805,000 U.S. customers, that opportunity may have presented at an inopportune moment. How can it return to profitability when its subscriber base is falling and international costs are pulling so hard?

  • Canada: Even the small profit Netflix has, 10 months after launch there, is due to turn negative again soon because it plans to double its content spend to match its U.S. outlay per capita. It is targeting consistent Canadian profit by Q3 2012.
  • Latin America: The company already had brand awareness in Canada, but rolling out to 43 countries in the region this year incurred big marketing outlay. “We are just beginning in this market with a lot to learn, and a lot we can improve over time, so it’s too early to tell whether we will reach run?rate break?even within two years as we would like,” the company says.
  • UK & Ireland: “While we normally target two years to profitability, with the increased competition in the UK relative to Canada, we anticipate it may take longer. We’ll know more after our first few quarters.”

Despite attracting a million Canadian subscribers, Netflix’s losses from international activities more than doubled to $23 million this Q3 alone after international marketing costs nearly doubled to $46 million.

Q4 losses from international are forecast to be far higher at $60 to $70 million, with slower revenue growth of $25 to $30 million from an estimated 1.6 to two million subscribers.

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Since Netflix isn’t holding or shipping DVDs outside the States, the main cost is marketing.

The company sees a strong UK opportunity. It told investors fewer UK than U.S. households currently subscribe to pay movies, that there are no Canadian-style broadband usage caps and that familiarity with over-the-top connected TV services like iPlayer and 4oD is growing.

“We believe our service, at an aggressive price, will be compelling,” it said, noting that Amazon-owned Lovefilm has more than a million customers paying about £10 a month for DVDs by post plus streaming access. “As in the U.S., it is not a winner takes all market; UK members will subscribe to Netflix and to other entertainment offerings,” the company added.

Netflix will be entering a market with relatively poor movie selection available online, according to research. That is partly because News Corp.’s well-funded Sky Movies subscription TV offering has the lock-up on Hollywood blockbuster exclusives. Sky’s lock-up has preliminarily been ruled anti-competitive by the UK’s Competition Commission. Breaking up Sky’s hold could mean a big opportunity for new entrants like Netflix, but some analysts don’t expect a remedy to kick in until 2014.

Despite the choice issue, the market Netflix plans to enter is served by a growing number of operators. As the BBC’s Future Media communications head Matt Phillips happened to tweet: “With Amazon/Lovefilm and Tesco/Blinkbox, Netflix is entering a crowded UK market: it will need very strong mix of content, UI, platforms and marketing.”

Both movie rights acquisition and marketing to stand out from the crowd will require exactly the kind of outlay that Netflix has warned about.