Video streaming giant Netflix (NFLX -3.92%) is firing on all cylinders. The company is on a roll, adding more than 2.7 million subscribers to its roster across the globe. Netflix's momentum in adding new subscribers in the future and boosting its earnings profile will be instrumental for the company's prospects going forward.
Domestic growing steadily
In the third quarter, the Netflix total subscriber base grew to more than 40.2 million subscribers. Top-line revenues grew 22% year over year to $1.12 billion. The company's diluted earnings per share grew to $0.52, which is a 300% increase from its year-ago earnings per share of $0.13.
In the U.S. market, Netflix added 1.3 million subscribers, which brought its domestic tally to 31.1 million subs. Revenues for U.S. streaming stood at $701 million. Contribution margin stood at 23.7%, which is an increase of more than 650 basis points on a year-over-year basis. Netflix is now bigger than Time Warner's (TWX) prized asset HBO in terms of domestic members. HBO has an estimated domestic member base of roughly 29 million, according to SNL Kagan.
Netflix bagged three Emmy awards in the third quarter, which helped it attract new subscribers in the U.S. However, Netflix is still well behind HBO in terms of Emmys and global subscribers.
Netflix's DVD business is still holding up pretty well, with 7.15 million subscribers, which drove a contribution profit of $107 million in the last three months. Netflix had 48 to 50 DVD distribution centers at its peak. Now it has 39 DVD distribution centers. The DVD business is here to stay for the foreseeable future.
Global growth story
For the first time, Netflix's subscriber additions in the international segment surpassed its U.S. subscriber additions. The company added 1.44 million subscribers from its international territories. Netflix is gaining heavy traction in international subs, which grew 113% year over year to 9.2 million subs.
However, the company did state that there was a lot of free-trial gaming in Latin America in the month of September, which briefly boosted its subscriber count. The company's international segment is still losing money, and the contribution loss margin stood at 40.6%. The company expects its contribution loss margin to decrease in the holiday quarter to approximately 30%.
Global consumers are using the streaming service heavily. Netflix's management disclosed in the earnings video that members streamed about 5 billion hours in the last quarter. This is up significantly from the company's previous usage update of 4 billion hours per quarter.
Netflix doesn't have a long-term target for scaling its contribution margin. Investors widely expect Netflix's contribution margin to scale like TV Networks, which makes a much more compelling valuation case for Netflix.
The company's management stated in its long-term view letter to shareholders that it will spend $500 million in 2014 to market itself across the globe and attract newer subscribers. Management did state its intention to expand into newer markets in 2014, after the company did well in adding subscribers in its existing foreign markets.
Eyes on Originals
Netflix's original show Orange Is the New Black has been a huge success for the company. Management disclosed that it is the most viewed original show on Netflix. In the fourth quarter, Netflix will roll out comedy specials from high-profile comedians like Aziz Ansari and Russell Peters as well.
The company hopes to ramp up the budget for original programming from current levels of 10%, and might even ramp up to the level of Time Warner's HBO, which has an original content budget of roughly 40% of its total content budget. Unlike other TV networks, Netflix doesn't have to take impairment charges for shows/movies that bombed in the U.S. box office. Netflix is keeping its options open in terms of the type and genre of movies it produces in the future.
Netflix is not the only one differentiating its service with originals. The company's rival in Internet streaming, Amazon.com (AMZN -1.64%), is also spending big money in adding five new original shows for its Prime Video offerings. Even though video offerings are not Amazon's core business, the presence of differentiated content on Amazon Prime and LOVEFiLM is a big plus. Amazon Prime subscribers pay annual subscription fees to the company and shop a lot more on Amazon's ecosystem, which creates a halo effect for the e-commerce giant.
Going forward
According to Netflix CEO Reed Hastings, the number of broadband households in Latin America will surpass those in the U.S. within the next five years. This will allow stellar growth in subscriber additions in the 40-plus countries where Netflix has operations. Some markets are particularly competitive, like the U.K. subscription video market with the presence of BSkyB, LOVEFiLM, etc. However, as a JPMorgan analyst pointed out on the conference call, according to Google search trends, Netflix is doing much better than Amazon LOVEFiLM in the U.K.
The development of high-profile shows like House of Cards is helping Netflix attract more creative talent from Hollywood, and the company stated that it will announce more shows. However, Netflix is competing with 40 different networks for the creation of original shows. Its ability to add leading producers from Hollywood will be critical for the success of its originals strategy in the future.
In the holiday quarter of 2013, Netflix's partnership with Virgin Media, the leading cable company in the U.K., will be rolled out. This should aid subscriber growth in the U.K. The company is also looking to add more cable companies to drive subscriber additions. Netflix's addressable market across the world is enormous, and the company is carefully looking to expand its footprint while maintaining its profitability.
