Is Netflix’s "Southern Strategy" Doomed?

08/16/2011 12:30 pm EST

Focus: GLOBAL

Rudy Martin

Editor, Investing Insight

Stepping into the Latin American market isn’t as easy as it seems from US shores, observes Rudy Martin of Latin Stock Investing.

While business and investment opportunities abound in Latin America, I continue to stress that the region must be approached with extreme caution.

Investors in Netflix (NFLX) are likely to learn this lesson—at least in the near term. On the other hand, investors in Grupo Televisa SA (TV), a leading Mexican entertainment firm, stand to potentially benefit from Netflix’s efforts.

After expanding its US customer base to Canada last year, early in July Netflix announced a plan to videostream movies and TV programs in 43 Latin American and Caribbean nations.

Three weeks later, on July 26, the Silicon Valley firm inked a multi-year deal with Televisa, the world’s largest producer of Spanish-language media, to annually distribute 3,000 hours of programming through Netflix.

Televisa, which now controls a reported 68% market share of programming for the Mexican TV audience, will benefit from wider distribution of its offerings. But Netflix faces some formidable challenges in its quest to become a Latin American entertainment conquistador.

Netflix—along with investors in its stock—should get answers to some disturbing questions about the firm’s Latin American expansion:

Do 43 varieties of culture and politics make for too big a bite?
The firm’s latest international expansion plan follows what seems to have been a successful expansion last year into Canada. But except for Quebec, Canada is essentially based on the same British heritage that shaped the early United States.

Now Netflix wants to deal with 43 countries of various sizes and political persuasions, whose heritages were variously influenced by the Spanish, Portuguese, French, Dutch, and Native Americans.

Will the new target audience pay Netflix’s price?
While $7.99 a month for datastreams or DVDs doesn’t seem objectionable for US households, how much will less-affluent Latin Americans and Caribbeans be willing—or able—to shell out every month?

Will collection for its services be an issue?
Credit card usage—and even consumer banking—in large parts of Latin America and the Caribbean lags the rate in the United States.

If users in the new markets tend to pay their bills in person with cash, wouldn’t the old-fashioned video store be a more viable business model than electronic distribution and collection of payments?

Although its product offering differs somewhat, will loyalty to DIRECTV (DTV)—which is well established throughout Latin America—hold consumers in the region back from allocating additional subscription funds to Netflix?
The satellite TV system’s Latin American business grew 40% over the past year, and now accounts for close to 20% of DIRECTV’s revenue. The marketing-wise firm is not likely to surrender Latin American market share without a bloody battle.

Does a significant percentage of prospective customers in Latin America have access to the necessary hardware and high-speed connectivity to access the less labor-intensive and more profitable datastreaming services?
On the last of these points, Netflix is already running into problems in its existing North American markets. The huge throughput requirement to download movies and TV shows is overloading the plumbing, according to Internet service providers.

For example, AT&T estimates that Netflix users account for 30% of peak-hour Internet traffic in North America. So land-line Internet and wireless suppliers are imposing extra subscription fees and data speed reductions on the heaviest users, which frequently include Netflix customers.

A recent change in Netflix’s pricing structure compounded the problem of higher connectivity costs in burdening users’ entertainment budgets. Whereas Netflix users previously paid $9.99 per month for both data-streamed content and DVDs by mail, the pricing was recently unbundled, with each service now costing $7.99 per month. Some users perceive this as a 60% price increase.

Netflix’s Latin American expansion plans haven’t immunized the firm from the recent stock-market implosion. Along with most US stocks, shares of Netflix have been in freefall in recent weeks.

Its price tumbled 20% during the three-week market downturn from mid-July to early August, a period that included the announcement of the Televisa agreement.

The challenges facing Netflix in its plan to expand into Latin America underscore our long-held philosophy that caution and selectivity are crucial for investments related to this region. Please be cautious about how you invest.

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