Netflix’s Telecom Alliances: A Game Changer for Global Market Penetration (NASDAQ:NFLX)

Investment Thesis

In January 2024, we improved our rating for Netflix (NASDAQ: NFLX) (NEOE:NFLX:CA) to buy, and the company’s stock is up 13% since then. Netflix stock just fell more than 10% from its peak. After By looking at the company’s fundamentals and assessing the potential for growth, I found that Netflix completely changed the way it approached business.

It is moving away from spending aggressively on content acquisition in favor of leveraging its user base by partnering with telcos to acquire and retain customers. As a result, the stock’s performance is more stable and the future growth trajectory is more visible. We recommend the company as a Buy, even though it currently trades at a premium valuation, as we believe it is supported by a solid growth strategy.

Q2 earnings recap

When Netflix mentioned that its telecom strategy was effective in Q2 earnings, we reviewed it and found that the company had a competitive advantage and significant room for expansion.

In 2023-2024, with telcos such as T-Mobile in the US, Vodafone in Spain, Telkom in South Africa, Jio and Vi in India, SK Telecom in South Korea and Deutsche Telekom in Europe, Netflix has made strides in collaboration. Telecom companies offer Netflix in their plans at no additional cost to the user. While we don’t know the specifics of the profit sharing in this deal, we can infer from Netflix’s financials that there is room for margin expansion.

Netflix claims the relationship adds value to the Internet Service Provider (“ISP”) by assisting in user acquisition, retention and upselling of higher tier plans. In addition, Netflix offers ISPs Open Connect CDN technology to reduce transmission costs and increase the efficiency of video delivery. For example, Netflix claims it will save ISPs $1.2 billion in 2020.

Using this method over the past two years has allowed Netflix to regain momentum in growing its subscriber base. Disney (NYSE:DIS) has tried to emulate this tactic, but Netflix has had more success thanks to its larger subscriber base and time-shared viewing, which allow for better negotiating terms. For example, Disney’s plan imposed an additional $10 fee (see chart below) from mobile users as part of Verizon’s partnership with Disney. In fact, Disney suffered because of it. Therefore, Disney did not gain as much from the telecom partnership as Netflix did.

In addition, as mobile users typically have varying contract renewal dates, this cooperative strategy ensures consistent 12-month subscriber base growth. As a result, investors can watch its user base grow. The latest deal Netflix has is with Vi, an Indian platform that was unveiled in June 2024 and has 218 million subscribers. In the future, Netflix can be successful with these tactics because it can now take advantage of its large user base to attract new subscribers and reduce the amount of money it spends on advertising to expand its own. Thus, Netflix stock should behave more like a defensive player. The company can shift from a content-based growth engine to a telco partnership model. This paradigm shift could be significant.

Netflix currently has a 22% penetration rate in UCAN. Other regions continue to be low, particularly APAC and EMEA. One explanation is relatively low brand awareness and consumer behavior in the region.

Additionally, financial data (see exhibit below) indicates that Netflix is ​​already reducing the ratio of content production costs to revenue.

Competitive advantage

YouTube

Netflix claims to have a 25% share of the US streaming market (see chart below), slightly less than YouTube. Although management noted that only 80% of TV viewing time is spent streaming, this still represents a significant opportunity to increase market share. Management reported that while TV timeshare fell in June, streaming services continued to gain market share.

Netflix has a larger subscriber base than YouTube (100 million). Additionally, Netflix has a business model advantage over YouTube in this environment as consumer spending begins to decline, which could reduce the motivation of YouTubers to create content.

Disney

Compared to Disney, Netflix has a scale advantage, and compared to Disney, it enjoys a profitability advantage. (see exhibit below)

Although Disney significantly improved its profit margins this quarter, its watch time fell to 2% (see chart above and below) and user base growth slowed to 1% (see May exhibit down).

While Disney has relied on other, more profitable businesses to support the development of Disney+, it now faces challenges from the decline of its cable business.

ASSESSMENT

There are currently over 7 billion mobile phone users worldwide (see chart below).

Netflix penetration in this area outside of UCAN is still quite low. (see exhibit below) Thus, the company’s collaboration with telecom players in APAC and EMEA will be a highly successful tactic to drive penetration in those areas.

The company’s price-to-earnings ratio (see chart below) has fluctuated throughout the expansion phase and bottomed out in 2022 at nearly 15 times the company’s subscriber base, which has fallen to single digits. Its forward P/E ratio to 2024 recently rose to 31x, indicating continued expansion.

Thanks to these partnerships, the company was able to maintain double-digit revenue growth in 2023 and increase its operational leverage. As a result, EPS growth reached 59%.

Management said the full-year operating margin target for 2024 was raised to 26%, up from the previous expectation of 25%. They indicated that content spending will grow at a slower pace than revenue, which will support margin expansion.

For the next three years, analysts have estimated EPS growth of 20% to 15%. (see exhibit below)

In our view, the company can shift from a content-based growth model to one focused on telco partnerships, and given the current low penetration rate, we believe the projected growth rate of 15-20% is likely conservative. From this perspective, the stock still looks undervalued.

Conclusion

In terms of viewing time and member base, Netflix has remained the industry leader in streaming. Because of this, Netflix is ​​better positioned to increase its alliance with international telecommunications providers and penetrate markets where its brand recognition is still relatively low. Additionally, this increases investor visibility into the company’s growth trajectory. As a result, even though the market expects Netflix to grow rapidly, we believe the valuation supports a solid growth strategy. With enormous potential, the company continues to penetrate the current TV industry. We think the stock still has room to grow as a result. In addition, the performance of the stock is more stable as a result of the paradigm shift of the business model. Therefore, we continue to rate it a buy.