Netflix Is a Great Buy for 2014

Online video giant Netflix  (NASDAQ: NFLX  )  is sitting pretty with more than 40 million subscribers. Netflix stock was the second-best performer in the U.S. market in 2013, with shares up almost 300%. But based on the booming growth in subscribers in the domestic and international markets, and its growing portfolio of original and exclusive content, Netflix still has solid upside in 2014. 

Domestic has room to run
Netflix's standard monthly subscription service offering, priced at $7.99, represents a great bargain for consumers. Considering the low price point and an increasingly wide breadth of content, including a great mix of premium and original shows and a superior user interface, it is reasonable to believe more U.S. households will subscribe to Netflix. The company has recently begun testing a variety of pricing plans that start as low as $6.99 a month for a single streaming plan.

The company had 31 million domestic subscribers at the end of the last quarter. The company's business model commands huge operational leverage, because most of the content costs of Netflix are primarily fixed costs. As a result, a large subscriber base will drive the company's contribution higher and boost its earnings per share. 

Netflix's management has stated that the company's U.S. opportunity stands at 60 million to 90 million. Based on the lower end of that guidance, Netflix will be able to rope in another 30 million new domestic users. Netflix how has more U.S. subscribers than Time Warner's  (NYSE: TWX  )  HBO. While HBO doesn't disclose its subscriber numbers, estimates from research firm SNL Kagan stood at 28.7 million at the beginning of 2013. And HBO is adding roughly 50,000 subs a quarter, while Netflix added 1.3 million domestic subs in its third quarter.

Of course, there are other subscription players. Ad-supported Hulu has 5 million paying subscribers and Amazon.com's Prime service has more than 20 million members. Netflix offers a much better user interface and more content compared to its competitors, which should keep its domestic subscriber base growing, and its churn rate should drop to a record low. Netflix is extracting incremental revenue from a small group of consumers through tiered pricing plans, like family pricing at $11.99 for four simultaneous streams. 

Netflix Originals
Netflix had a fantastic 2013 based on its very successful original content strategy. The company's shows like House of Cards and Orange Is the New Black have been instrumental in growing Netflix's global brand value. 

Management stated it will increase its original content budget from 10% of its total content expenditures to much higher levels, to the tune of 15% to 20% in 2014. Netflix is spending close to $3 billion a year for content, and if the company allocates 20% of that toward developing high-quality originals, it will have a much more robust original library. The development of more Emmy-winning shows will attract newer audiences to Netflix, and give the company more pricing power.

Amazon and Hulu are developing their own originals, but Netflix has been a lot more successful in building high-quality franchises. The company will be unveiling season two of the critically acclaimed House of Cards in February. And a much larger original library similar to Time Warner's HBO will lay the foundation for possibly raising prices modestly to $8.99 or $9.99 a month, and still remain a valuable service and a bargain for consumers. 

International growth and profitability
Netflix has been growing its international business by reinvesting the profits from its domestic DVD and streaming business. As a result, the company now has 9.2 million international subscribers in roughly 40 countries. The rapid growth in domestic contribution profits will enable the company to invest heavily in its international segment, which is a gigantic addressable market.

And the company hasn't even launched in a number of large markets, such as Russia, China, and India, which makes it reasonable to believe that its international user base could one day surpass its domestic subscriber count easily.

In terms of profitability in the international market, Netflix should continue to lose money in the near term as it is investing heavily in building large localized content libraries for each country/region. The only profitable country in the international segment is Canada, and as other markets mature, Netflix's profitability should get a major boost. 

The takeaway
Netflix can easily grow its penetration rates in the U.S., and gain a lot of new members in its international segment. The company's management team has done a fantastic job of widening its moat and executing on its long-term vision. Netflix has a number of years of double-digit revenue growth ahead, and will receive substantial tailwind from secular consumer trends. Taking all these factors into account, Netflix seems headed higher in 2014.

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Read/Post Comments (7) | Recommend This Article (1)

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 January 06, 2014, at 6:56 PM, AceInMySleeve wrote:

    Of course a lot of this is baked in, so you need to actually get into modelling the numbers...

  • Report this Comment On January 06, 2014, at 11:32 PM, ishfaque wrote:

    You are partially correct. A small part of the future upside is baked in. If you believe that, Netflix can add 7-8 million subscribers each year across the globe, there is still a huge amount of upside left.

    My NFLX model points to an intrinsic value for the company anywhere between $475-$530.

  • Report this Comment On January 06, 2014, at 11:33 PM, dinopontino1 wrote:

    This article is ridiculous.

    First of all, House of Cards isn't good, it's un-watchable. Additionally, season 3 is going to cost Netflix ~100 Million dollars at least. Please actually watch the shows before you blindly endorse them. Orange is good.

    Secondly, Netflix has no deals to stream in Russia Or China and probably won't as their governments don't want to give up the revenue streams of the state channels. Let's see if Netflix can get through the barriers to entry before we start counting other markets as opportunities.

    Thirdly, HBO GO, AMAZON, and HULU are all on Netflix's heels now and I wouldn't be surprised to see VIACOM throw all future content at Amazon Instant as DISNEY does the same with HULU to maximize its investment in HULU.

    Netflix and Amazon have had the same new movies released for 3 months now, Jack Reacher, Flight, Skyfall so it's not like Netflix is streaming anything that Amazon isn't. Amazon will probably spin instant away from prime in 2014 for about $4-5/month.

    And I emailed Amazon support today about streaming over Apple TV and Chromecast, this was their response:

    Apple TV:

    Support over airplay

    Chromecast:

    "I'd like to tell you that we've recently received many suggestions from our customers to make Amazon Instant Video available for "ChromeCast" support and our technical team are currently working on introducing this device on Amazon Instant Video compatibility list as per our customers request."

    So before you predict anything for Netflix, do your homework.

    This business is GROWING and Netflix is the leader but there are very very very serious risks that aren't being priced into this stock and its time for the market to accurately assess this company.

  • Report this Comment On January 07, 2014, at 12:23 AM, Fo45 wrote:

    These are the serious downsides of Netflix first increased content price, increase content delivery (ATT started the movement and soon it will be followed by cable companies), roaring competition .

  • Report this Comment On January 07, 2014, at 1:19 AM, sliderw wrote:

    Netflix has continuing problems with its Latin America market. It doesn't bode well for Netflix getting into other emerging markets, like the three you cited -- Russia, China, and India.

  • Report this Comment On January 07, 2014, at 10:22 AM, golfer208 wrote:

    Since there are less than 100 million domestic households, you might want to rethink management's optimistic projections. As far as foreign, its a losing business.

  • Report this Comment On January 07, 2014, at 5:43 PM, ishfaque wrote:

    Golfer208: The number of US Households was in excess of 121 million in 2013. My guess is --it goes in only one direction.

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