This is our second set of surveys of international markets that we believe are representative of Netflix’s international subscriber base. Over the past quarter, international churn has remained constant at 41% while the US churn fell about a quarter from 17% to 13%. A stagnation in churn despite increased investment in local language content will prove harmful to the customer lifetime value (CLTV)/ customer growth costs (CGC) ratio- the SaaS metric on which Netflix trades.
Our Surveys- We have used Mexico as a proxy for Spanish speaking markets, Germany for European markets and Japan for Asian markets. Through the surveys we were able to determine the annual churn rate, reasons for churn and the market penetration rate.
The Annual Churn Rate – The percentage of users who have left Netflix over the last 12 months. Exhibit 1 shows the change in churn rate for each of the countries vs how long Netflix has been present in those markets. The churn in Japan seems to be fairly consistent, hovering around 51.5% while that for Germany has improved 6.5%, moving from 51.88% to 48.51%. The largest and most surprising change comes from an increase in Mexican churn by 12%, moving from 22.8% to 25.61% over the past three months. This change is surprising as Netflix has well-known and highly admired Spanish language shows like Narcos and Club de Ceurvos being released in this time frame. The management has also emphasized the importance of going local and its the contribution towards attracting and retaining international subscribers.
The annual international churn of 41% is calculated by weighing these individual market churns on GDP, population and years since Netflix’s launch.
EXHIBIT 1: Churn Rate vs. Presence in International Markets
Source: Perspectec
The Penetration Rate – The percentage of users who have or have had a Netflix subscription over the last 12 months. Exhibit 2 shows a decline in penetration for all 3 of our proxy markets. It is worrisome that Netflix will have to step up its current customer acquisition/growth spending considering the negative $2-2.5 billion FCF and $7-8 billion estimated content spending next year.
EXHIBIT 2: Penetration Rate vs. Presence in International Markets
Source: Perspectec
Reasons why subscribers left – All users who have left over the past year are categorized by the reason they have left as seen in Exhibits 3 to 5.
The reasons for churn were:
Mexico:
- The service was too expensive
- The content got boring
- The subscriber moved to another platform
- The free-trial ended
Germany:
- The service was too expensive
- The content got boring
- The free-trial ended and the subscriber moved to another platform
Japan:
- The free-trial ended
- The content got boring
- The service was too expensive and the subscriber moved to another platform
Price seems to be the most important factor for most markets, followed by lack of engaging content. With Amazon undercutting Netflix on price in most countries and Netflix’s trend of raising prices to cover content costs, an increase in global churn in likely.
EXHIBIT 3: Mexico survey results
Source: Perspectec
EXHIBIT 4: Germany survey results
Source: Perspectec
EXHIBIT 5: Japan survey results
Source: Perspectec
What this means for our SaaS model: Based on an international churn rate of 41% and US churn rate of 13.25%, Netflix’s overall churn to be about 26.6%. Based on the declining global market penetration, a conservative case scenario would be to assume global churn remains constant over the next 12 months. If the absence of improvement of churn, Netflix will move to a Sell rating with its CLTV/TTM CGC falling from 1.4x in Q3 2017 to 1.1x in Q3 2018.
Using our updated churn statistics and Q3 2017 financials, we have updated our SaaS metrics and show what it means to relative valuation below. We measure fair value EV/EBITDA aT 100x CLTV/TTM CGC.
EXHIBIT 5: Comparison of SaaS metrics for Netflix and its peers
Source: Company Reports, Perspectec
Conclusion:
SaaS metrics point towards a worrisome future– Even with a conservative view on churn, we see Netflix moving to a Sell rating over the next 12 months.
Local language shows alone can’t drive penetration – The management strongly believes local language content is what fuels subscription growth. Despite considerable investment in Spanish content, penetration in Spanish-speaking markets doesn’t seem to be improving.
Based on the trajectory churn and penetration are following, we are issuing a hold rating on Netflix until we can get more clarity after conducting our mid-quarter subscriber addition update.
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For the purposes of complying with NYSE, NASDAQ and all Self-Regulatory Organizations, Perspectec Inc. has assigned the following rating system BUY, HOLD/NEUTRAL, SELL for the securities which are the views expressed by an analyst, Independent contractor, and or an employee of Perspectec Inc. The information and opinions in these reports were prepared by Perspectec Inc. or an analyst, independent contractor. Though the information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Perspectec Inc. makes no representation as to its accuracy or completeness.
