Netflix Shares Should Double When the Company Crosses This Bridge

In the spring of 2012, I outlined a $300 target price for Netflix (NASDAQ: NFLX  ) . The goal seemed lofty, since Netflix shares traded for just $104 at the time. Then again, I gave the stock four years to get there, since my math was based on expected results in 2016.

Twitter user Brad Smith remembered that old story and wondered aloud: "Great call. Have you raised your target since then?"

It's a fair question. Netflix shares are hovering just below that once-audacious $300 level again, and it's only been 17 months. It's high time to revisit the old math and see if it still makes sense. Should investors still expect Netflix to trade at $300 in 2016, or has the company entered a whole new growth trajectory?

This chart will help me answer that question:

Data taken from Netflix SEC filings.

As it turns out, I made some overly conservative assumptions in the spring of 2012. For one, domestic streaming numbers have accelerated since then, indicating that Netflix may reach its final destination at 60 million to 90 million U.S. streaming subscribers faster than previously thought. But that's not even the most disruptive point this chart makes.

Netflix is going global -- fast!
Netflix put the pedal to the metal on international opportunities faster than I had expected. My 2016 targets assumed that Netflix would take an extended break from overseas expansion, announcing its next markets in 2013 or maybe even 2014. The final tally included just "a modest contribution from the international market" by 2016, since the expansion here was taking a breather.

Well, four months later, Netflix leveraged its rampant international growth and announced its next expansion way ahead of schedule. Scandinavia was followed by the Netherlands this summer, and that's hardly the end of this aggressive push.

In the recent second-quarter report, management said that the expansion will continue in 2014 based on surprisingly strong results in existing international markets and high confidence in the opportunity ahead. And it's all done with lower overseas content spending than management had expected to need. Oh, and international subscriber totals quietly passed the number of DVD customers.

There's nothing wrong with the domestic market, where streaming subscriptions jumped 25% year over year in the second quarter. But international subscribers more than doubled, and it's only a matter of time before overseas subscribers and revenues outgrow the domestic market.

That's the crossover point that Netflix investors can't wait to see. My updated model indicates that it'll happen sometime in 2016, which means that the domestic value meets its match overseas that year. In other words, I wouldn't be surprised to see subscribers and revenues nearly double the old expectations.

What's the big deal?
Looking at Netflix's current international results, you might wonder why investors should even care about non-U.S. growth. After all, the international division is reporting operating losses amid this rampant subscriber growth. That old joke about balancing negative margins with high volume springs to mind.

But then you're forgetting that it costs money to start new markets from scratch. Netflix has to build some infrastructure in every new territory, and then the marketing blitz begins. Netflix turned its first Canadian profit in 2012, setting the bar for Latin America and the various European markets to follow.

By 2016, all of these geographies will be mature and profitable -- not to mention much larger than they are today. And whatever markets Netflix launches in 2014 should be well on their way to operating profits as well.

In short, overseas subscribers should pull their weight for Netflix profits in 2016. If nothing else, the trajectory toward equal operating margins inside and outside America should be very clear.

The Foolish takeaway
In the final analysis, my old targets have been moved by a strong return to international growth that didn't seem to be on the table in early 2012. I'll be very disappointed if Netflix hasn't doubled again three years from now, because that means either that the domestic addressable market is smaller than expected or that the international bonanza hit a brick wall.

I hope I've answered Brad's question with a very clear "yes." Netflix remains my largest personal holding and my most successful CAPScall to date, and I expect at least three more years of market-crushing success.

Americans reportedly spend nearly as much time watching television as they do working. The potential for profits in the space is enormous, not to mention the global expansion opportunity. The Motley Fool's top experts have created a new free report titled "Will Netflix Own the Future of Television?" The report not only outlines where the future of television is heading, but offers top ideas for how to profit. To get your free report, just click here!


Read/Post Comments (11) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 02, 2013, at 7:14 PM, nonotme2 wrote:

    Netflix doesn't care at all about the American market that is unless it is the few new signers. Once you watch the extremely limited selection of American movies you drop them like a lead balloon as I and so many more have done. So the growth for Netflix is the rest of the world; outside of the U.S. Well good for Netflix! and the investors. As for Netflix being a great company the answer depends on who is asked the question...the American consumer or the the World's investor's!?

  • Report this Comment On September 02, 2013, at 7:50 PM, duuude1 wrote:

    Anders, duuude, you're singing my tune!

    Bought back in March and June of '07, and within a month I had lost 20% of a decent investment. I didn't sell. Within a year it had doubled. I didn't sell. A few months later by Oct '08 it lost half but I hung on.

    Then the rocket's engines lit, my head snapped back, and NFLX accelerated to $300 by Jul '11. Fifteen times my original investment. I didn't sell.

    Then Flixter happened.

    I grabbed for falling knives all the way down until the blades were buried to the hilt from my jugular all the way to my nether regions. Still holding every damn share in my bloody hands.

    Tell you what, this is NOT a stock for nervous people.

    I'm a buy-and-hold contrarian. Most of my investments are in index funds and so I sleep very well. Always buy, never sell. But the small amounts of play money in a few individual stocks like NFLX and AAPL have powered far past the core foundation of my index funds - and I'm letting those babies run.

    Buy companies run by great people, making great products, and ignore the haters. Stay strong through rough patches like Flixter and AAPL's current anemia. Keep ignoring the haters. They'll be eating cat food from a warm can.

    Duuude1

  • Report this Comment On September 02, 2013, at 11:47 PM, mountain8 wrote:

    +1,662.38%: That's the gain on my first 100 shares bought in July 07 at $16. How humbling.

    This is my last buy, 30 shares Acquired 08/06/2012 +409.21%

    I only have one buy at less than 100%. It's only 34% since last year.

    You sell if you want. It's a personal decision. :-)

  • Report this Comment On September 03, 2013, at 1:16 AM, 12OnAHunch wrote:

    Anytime you have a stock that is 80% owned by large investment companies you are going to get false prices since they will continue to add the stock at whatever price to maintain the stock's price. Since the membership is free the first month and only $7.99 monthly after that most people don't cancel even though they most likely don't even use the service. That is why Netflix isn't planning on raising their rate and if they you'd see a big drop in their membership numbers.

  • Report this Comment On September 03, 2013, at 8:34 AM, pauldeba wrote:

    Even if they get 90 million domestic and 60 million international, a $600 stock price would imply 12.5x earnings ($10 per monht, 33% gross margin, 750MM advertising, 300 million R&D and 300 million G&A and a 38% tax rate), I guess you think there's still some growth left after that. at 60 million and 40 million the P/E would be about 20.

    it's absurd to think it can get there at all, let alone with increasing competition. The $300 price initially came when analysts were predicting 40 million domestic subs and $7 per share for 2012. They didn't make 30 million or 10% of their projetced earnings.

    Now, they're expecting $3 per share and 38 million subs by 12/14 to get it to $300 again. I guess if they can make $2 it will go to to $400.

    The stock price is a joke, they will never get near these figures. They had 25.5 million domestic 2 years ago and gained 6 million in 2 years, assuming they never saturate the domestic market it will take more than 9 years to get to 60 million. and no competition, ever.

    Simple math proves they will stall at 35 million. They have 15% churn and maximum new signups is 6 million, with an average of 5.25 million per quarter. at 35 million, churn equals new signups. unless you think they will be signing up 8 million when they churn 6 million, or people will simply stop churning, even though those figures hold pretty well over time. we won't see any growth after 35 million.

    International is worse, growth slows after 9-12 months in each market. They got crushed going after big markets like Brazil, and went after more niche and marginal markets like Scandinavia and the Netherlands. These countries have a highly educate, globally aware and very proficient English speaking population. That is the key for them, it won't be the same in more provincial, nationalistic places like France, germany, Italy and Spain - it won't work in big countries

  • Report this Comment On September 03, 2013, at 10:22 AM, TMFGemHunter wrote:

    I don't think the market opportunity is that big. Could Netflix get 60 million U.S. subscribers in a decade or two? Maybe. But 90 million just seems ridiculous, and the company has never supported those figures with any hard evidence. (It seems to be back of the envelope math: HBO has 30 million, but Netflix is cheaper and has more content, so maybe it could be 2-3 times HBO's size.)

    I don't agree with pauldeba, though: there's no reason to believe that 35 million is a ceiling for some reason. However, it is true that the more Netflix grows, the harder it will be to keep growing.

    I think the next 2 (or maybe 3) quarters will be a watershed. Netflix fired all of its bullets by July 2013 with premieres of its top 4 originals (House of Cards, Hemlock Grove, Arrested, and Orange is the New Black). Meanwhile the biggest content losses of the year (Nickelodeon kids and Downton Abbey) didn't occur until roughly mid-year. I'm expecting growth to drop below 2012 levels in the second half of 2013 as a result of fewer signups (b/c of less support from Originals) and an uptick in churn (due to content losses).

    Adam

  • Report this Comment On September 03, 2013, at 1:00 PM, pauldeba wrote:

    "there's no reason to believe that 35 million is a ceiling for some reason. "

    That's fine, but explain, what will change - More new signups or lower churn. I see the two staying the same like they have for the past several years.

    Churn will be 18 million unless customer habits change, all of a sudden and new signups will have to be 19 million to have any growth, at all. Not sure where the 19 million are coming from, when 20 million was the highest they ever acheived the year of the Blockbuster bankruptcy. will some other competitor exit and Netflix make gains from? sorry, but netflix is the new blockbuster, they can't win that battle again

  • Report this Comment On September 03, 2013, at 2:31 PM, TMFGemHunter wrote:

    @pauldeba: Netflix is on pace to add 6 million domestic subs this year from a base of 27 million. If quarterly churn is actually 15%, that would imply that quarterly sign-ups are averaging closer to 6 million than 5.25 million. (Alternatively, churn could and gross adds could both be lower.)

    Based on those numbers, ~40 million would be the asymptotic ceiling. However, Netflix is trying to drive churn significantly lower by differentiating its content with the original shows and hopefully improving its content library overall. I'm skeptical that the content library will improve enough to get Netflix to 60-90 million subs anytime soon. My best estimate of YE 2016 Netflix domestic subs is 45-48 million, assuming no price increases. But obviously that depends a lot on the strategic choices made by Netflix and competitors.

    Adam

  • Report this Comment On September 03, 2013, at 3:08 PM, pauldeba wrote:

    "Netflix is on pace to add 6 million domestic subs this year from a base of 27 million. If quarterly churn is actually 15%, that would imply that quarterly sign-ups are averaging closer to 6 million than 5.25 million. "

    That's simply not true. They've gained 2,350 through June, excluding the 300 DVD only that churned. They will gain 1 million in Q3 less another 100K DVD churn. That's 3,250. If they can do anothe 2 million in Q4, that will be 5.25 million for this year. Let's remember that 5 of the past 8 quarters have been disappointments, so to project future based on 2 good quarters of the last 3 seems suspicious. alos, when DVD churns to zero, one source of new signups (former DVD only) will be gone), so they'll still have churn but fewer signups.

    The way I look at churn and signups, now that they don't report is to see how much paid subs make up the total. The more free subs you have, the more signups, the higher it gets, the poorer the quarter was, it is getting closer and closer to 100%. The March quarter this year seems an aberration, but I think that may be Xmas gift signups that went live in January, so may have been a poor quarter post January 15.

    Saturation has to be coming, who th heck never signed up for netflix? I have a hard time finding anyone that hasn't and has interest in it.

  • Report this Comment On September 04, 2013, at 6:36 PM, UberMe wrote:

    All these comments and a 1/2 decent article yet no one has mentioned Carl icahn...weird.Held put in $350 million now it's 400% retrun.

  • Report this Comment On October 03, 2013, at 11:06 AM, ftlcowboy wrote:

    Google Chrome is going to drive sales for them. It will increase the size of the domestic pie.

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