UK office market A feasible entry option for Netflix? In-depth research

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1 A feasible entry option for Netflix? In-depth research 4 March 2015 Report summary Purpose Methodology Major sources To conduct in-depth research on the topic Secondary research using recognised databases and freely available sources General web search

2 Client query We are pitching Netflix to help them decide the feasibility of opening offices in the UK. Please help us find out their current office locations and space requirements. We would also like to know about office rents in different locations across the UK. a UK-based real estate consulting firm 2

3 InsightBee research 1 Introduction 1 Netflix Inc (Netflix) has eight principal properties: six in the US and one each in Brazil and the Netherlands. Through these eight properties, it provides digital distribution of TV shows and movies to its 57.4 million subscribers (as on 31 December 2014) in about 50 countries. Through its US offices, it also provides home delivery of DVDs in the country. The company s offices in Brazil and the Netherlands serve as its regional headquarters for Latin America and Europe, respectively. Netflix established its Latin America headquarters in São Paulo in 2013 and relocated its Europe headquarters from Luxembourg to Amsterdam in These two regional headquarters support its data acquisition, marketing and customer support operations. 2 The company also set up an office in Sydney, for its expansion into Australia and New Zealand, and is expected to start operations in March Netflix s subscriber base is projected to expand in the coming years. With this expansion, its real estate requirements will also increase. The company already has plans to expand both within and outside the US. The scope of this study is to figure out the feasibility of its opening offices in various regions of the UK. 1 Annual report Variety.com article, 11 October 2013 / Netflix Rollout in Europe Begins With France, wsj.com, 15 September Confirmed: Netflix Is Coming to Australia, No Pricing Provided Yet, techly.com, 19 November

4 2 Netflix - Current office locations 2.1 Principal properties The following table provides details of Netflix s eight prinicipal properties: Location Country Area (sq ft) Los Gatos, California Lease expiration date Type of space US 250,000 March 2018 Headquarters Primary use Global streaming corporate office, general and administrative, marketing, and technology and development Columbus, Ohio US 90,000 August 2016 Distribution centre Domestic DVD receiving and storage centre, and processing and shipping centre for the Columbus area Beverly Hills, California US 79,000 August 2018 Office Global content acquisition, marketing, and general and administrative Fremont, California US 57,000 March 2019 Office and distribution centre Domestic DVD corporate office, general and administrative, and technology and development Hillsboro, Oregon Santa Clara, California US 49,000 April 2016 Call centre US 23,000 October 2016 Office Domestic streaming and domestic DVD customer service centre Global streaming customer service centre São Paulo 4 Brazil NA NA Office Latin America headquarters Amsterdam 5 * Netherlands NA NA Office Europe headquarters As is clear from the above table, Netflix has a total leased area of 548,000 sq ft in the US. Customer support centres and content acquisition, marketing, and general and administrative offices occupy ~38% of this space. 2.2 Office expansion plans On 4 February 2015, Netflix announced that it will open a regional office in Tokyo to build close partnerships with consumer electronics makers and Japanese film and TV creators. 6 In 2013, the company entered into a 124-month lease agreement to expand its Los Gatos headquarters by 263,000 sq ft. The expansion work will be completed in Variety.com article, 11 October Amsterdam New Home to Netflix Europe Hq, nltimes.com, 21 May Netflix to launch in Japan this fall, netflix.com, 4 February

5 3 UK office feasibility study Methodology: We compared the number of Netflix subscribers in the UK with that in other European countries in 2014 and Then, we calculated Netflix s current rent expenditure by considering the rent benchmark on the basis of rent/sq ft/year of the present US premises. We then used the CAGR of office rents in various regions of the UK from 2010 to 2014 to determine the most feasible area for office space acquisition. Limitation: For the calculation of Netflix s average rent/sq ft, we considered only the area of its US offices because of unavailability of data on the size of its other offices outside the US. 3.1 Why Netflix should consider opening new offices in the UK Expansion of the UK subscription base The company s US subscriber growth is expected to decline by 30% y-o-y in In 2014, Netflix s UK subscription base was its largest in Europe, with approximately 3.3 million subscribers, and is forecast to increase at a CAGR of 9.4% from 2014 to 2018 to reach 4.7 million and still remain the largest in Europe. 9 7 Europeans Will Comprise One-Fifth of All Netflix Subscribers by 2015, IHS Technology Report Says, Press.ihs.com, 22 August Top Ten Digital Media Predictions for 2015 according to Strategy Analytics, prnewswire.co.uk, 15 December Values extracted using webplotdigitizer 5

6 Office rents (GBP/sq ft/year) UK office market Increasing US rental expense Netflix predicts that its future minimum lease payments in the US will increase till 2016 as follows: Year Minimum rent expense (GBPm) y-o-y increase % 2015* % 2016* % * Future minimum payments under lease financing obligations and non-cancelable operating leases as on 31 December 2014 Analysis: Driven by an increase in domestic rent expense, a decrease in domestic subscription growth and an increase in UK subscription base, the company should consider opening new offices in the UK to get closer to its subscribers and also to facilitate its content acquisition, marketing and customer care offerings. 3.2 Office rental expense 13,14 Netflix s US rent expenses associated with operating leases were GBP16.1m 15 during FY Its total leased area in the US was approximately 548,000 sq ft in This amounts to an approximate rent of GBP29.5/sq ft/year. In the UK, many major cities have much lower office rents. The below figure highlights the seven major cities whose office rent/sq ft/year was lower than or equal to Netflix s US rent/sq ft/year in UK office rents Exchange rate USD1=GBP (average of 2014) 11 Exchange rate USD1=GBP (as of 31 December 2014) 12 Exchange rate USD1=GBP (as of 31 December 2014) 13 Marketbeat office snapshot - US, Cushman & Wakefield Research Publication, Q Marketbeat office snapshot - UK, Cushman & Wakefield Research Publication, Q Exchange rate USD1=GBP (average of 2014) 16 Annual Report 2014, Netflix 6

7 The seven cities highlighted above also had a lower CAGR of rents in the past five years than other major UK cities, as shown in the following figure. Birmingham Bristol Newcastle Leeds Cardiff Edinburgh Glasgow Manchester Reading London (City) London (West End) CAGR of office rents from 2010 to Analysis: Edinburgh, Glasgow, Birmingham, Bristol, Leeds, New Castle and Cardiff would be favourable locations for Netflix to open offices in as the rent/sq ft/year in these regions is comparable with the rent expense of the company in the US. Also, these regions have not witnessed much fluctuation in their rent/sq ft/year values in the last five years. 3.3 Regulatory factors in the UK 17 Regulatory Factors UK business rates Business rates relief schemes Other business costs Registration process/ Taxes The governments in the UK provide business rate exemptions to encourage business. For more information on the type of rate reliefs, eligibility criteria and the relief provided in Engalnd, Scotland, Wales and Northern Ireland, go to Appendix. Some of the other costs related to leasing commercial property are local authority charges for services, insurance, repairs and maintenance, running costs or service charge, Stamp Duty Land Tax (SDLT) on leases, deposit and VAT. The registration process and taxes in the UK depend on the type of office a company wants to open. Analysis: Out of the seven favourable cities identified for Netflix s UK expansion in Section 3.2, Bristol (South West Engalnd) and Cardiff (Wales) are probably benefitting from the deferred business rates revaluations. The remaining five cities are probably paying more business rates than they would have if the revaluations had not been postponed. 17 UK Business Rates, knightfrank.co.uk / Business rates in the UK: who are the winners and losers?, theguardian.com, 19 March 2014 / Business rates, gov.uk / Rental and Additional Costs for Commercial Property Tenants, movehut.co.uk / What does an overseas company need to open an office in the UK?, primefind.com 7

8 4 Conculsion Netflix would need to increase its office space internationally to provide services to its growing customer base in different markets and manage costs due to increasing rental expense. Globally, the company s expansion has seen a boost in Europe, particularly in the UK where its subscription base is forecast to increase at a CAGR of 9.4% from 2014 to Within the UK, Edinburgh, Glasgow, Birmingham, Bristol, Leeds, New Castle and Cardiff would be favourable locations to open offices. The office rent in these cities is either equal to or lower than Netflix s current US rent. Moreover, in the past five years, the CAGR of rent in these cities has been lower than that in other major cities in the UK, including London and Manchester. Out of the above-mentioned cities, after assessing the business rate revisions and government rate relief schemes, the two most favourable cities to open offices in for Netflix are Bristol (South West Engalnd) and Cardiff (Wales). 8

9 5 Appendix 1. The following table shows the percentage of locations that will pay less, pay the same or pay more business rates due to the delay in revaluations in different regions of the UK: 18 Region Paying less (%) Paying the same (%) Paying more (%) London South East South West West Midlands East Midlands East of England North East North West Yorkshire and The Humber Scotland Wales The types of business rate relief schemes, eligibility criteria and relief provided in England, Scotland, Wales and Northern Ireland are mentioned below: England provides the following types of business rate reliefs: small business rate relief, rural rate relief, charitable rate relief, enterprise zone relief and retail relief. The rate reliefs relevant to office space are mentioned below: Type of relief Criteria for qualification Details Small business rate relief Transitional rate relief Enterprise zone relief The owner uses one property. The property s rateable value is less than GBP12,000. The property s rateable value was not GBP0 at any time since 31 March It is not new and has been included in a revaluation. The owner starts or relocates to an enterprise zone in England by March % relief (doubled from the usual rate of 50%) until 31 March 2015 for properties with a rateable value of GBP6,000 or less. Rate of relief gradually decreases from 100% to 0% for properties with a rateable value between GBP6,001 and GBP12,000. As a consequence of the national business rate revaluation, if the rateable value of the property changes significantly, the business rates will change gradually. Up to 100% business rate relief for five years, up to a maximum of GBP275, Business rates in the UK: who are the winners and losers?, theguardian.com, 19 March

10 Scotland provides the following types of business rate reliefs: small business bonus scheme, fresh start, new start, rural rate relief, charitable rate relief, disabled persons relief, enterprise area relief and renewable energy generation relief. The rate reliefs relevant to office space are mentioned below: Type of relief Criteria for qualification Details 100% rate relief for rateable value up to GBP10,000. Small Business Bonus Scheme New Start Fresh Start Enterprise area relief The combined rateable value of all business premises in Scotland is GBP35,000 or less. The property was built on or after 1 April The owner occupied the property on or after 1 April 2014 and the property had previously been vacant for at least 12 months. The property has a rateable value under GBP65,000. The last use of the property was as a shop, office, restaurant, pub or hotel, or where there was no previous use, the intention is to use it as a shop, office, restaurant, pub or hotel. Businesses starting or relocating to an enterprise area site and doing work in certain sectors 50% rate relief for rateable value between GBP10,001 and GBP12, % rate relief for rateable value between GBP12,001 and GBP18, % rate relief on each individual property with a rateable value between GBP18,000 and GBP35,000. Rate relief up to 100% for 18 months. 50% business rates discount for their first year in the premises. 100% relief up until March Wales provides the following types of business rate reliefs: small business rate relief, charitable rate relief, rate relief for empty properties, hardship relief, open for business scheme and new developments scheme. The rate relief relevant to office space is mentioned below: Type of relief Criteria for qualification Details Small Business Rate Relief Property s rateable value is less than GBP12,000 A rateable value of GBP6,000 or less is eligible for 100% relief. Rate of relief decreases from 100% to 0% for properties with a rateable value between GBP6,001 and GBP12,000. Northern Ireland provides the following types of business rate reliefs: small business rate relief, empty premises relief, small business rate relief for small post offices, charitable exemption, sport and recreation rate relief, residential homes rate relief, industrial derating, non-domestic vacant rating, hardship relief, relief for automatic telling machines (ATMs) in rural areas and relief for shop window displays. 10