Why Netflix Has Immense Upside From Here

Netflix is becoming supremely dominant in Internet video and hopes to have 48 million global subscribers this quarter. The company's big investments in content are paying off and its margins are on the rise. is now the time to book profits or stay on board for more possible gains to come?

Jan 28, 2014 at 10:40AM

Netflix (NASDAQ:NFLX) has been doing very well lately. The company's subscriber base surged to 44 million members spanning 41 countries. Netflix had a blow-out holiday quarter and it came in well ahead of expectations. The company hopes to surpass 48 million subscribers in the first quarter of 2014, and in the process, cement its position as the largest Internet TV network in the world. 

Margin expansion in domestic
Netflix added roughly 2.33 million subscribers in the U.S., and it now has more than 33.4 million subscribers in the domestic market. The company's subscriber count surged well past those of its competitors, including Amazon.com's (NASDAQ:AMZN) roughly 20 million customers and Hulu's paid subscriber base of 5 million. Also, Netflix expects to add 2.25 million subscribers in the current quarter.

A number of analysts have been skeptical on Netflix and they have downgraded the company's stock which owes to the growth of Amazon. Amazon revealed its subscriber count for Instant Video for the first time and it invested in developing original content as well. However, the growth of Internet TV has lifted the fortunes of both companies and competition between these two companies is rather indirect.

Netflix's scale and subscription revenue model have been critical in expanding margins, as the company expects its contribution margin next quarter to grow to roughly 24.9%. Netflix's management stated that the company is on track to achieve a 30% contribution margin in the domestic market by 2015.

Netflix's DVD business is still doing well with a gigantic DVD selection and it has roughly 6.9 million subscribers. This DVD segment of Netflix still provides valuable contribution profit dollars to the tune of $110 million in the last quarter. Going forward, the DVD segment is expected to scale down very slowly.

International nears profitability
In the last quarter Netflix's international operation achieved a positive gross profit for the first time. The company hopes to make big investments into developing its content library for its European viewers.

A bigger stable of original shows will drive brand awareness in Netflix's international markets, and in turn, aid subscriber growth outside the U.S. Netflix's management hopes to make a big expansion in select European countries during the latter part of 2014.

Netflix's deal with Virgin Media, which will allow its services to be offered via set-top boxes, should aid its growth prospects in the region as well. In addition to Virgin Media, the company also offers the same service in partnership with Waoo! in Denmark and Com Hem in Sweden, and Netflix hopes to add smaller domestic cable providers soon. 

Content is king
The company stated that it will continue to grow its original content budget in 2014. Netflix's management disclosed that some of its original shows saw spikes in viewers due to a host of award nominations and wins that included the Emmys and the Golden Globe Awards.

The company plans to raise $400 million in new debt in the current interest rate environment, which will give it more flexibility in funding more originals. Netflix has been adding differentiated and exclusive content like comedy specials and high-quality documentaries as well.

Netflix will release the second season of House of Cards in February, and this release might lead to very strong subscriber additions. Netflix has kept the door open for movie production and it is considering the production of big budget Netflix-only movies with its ever-growing content budget.

The company is heart-set on developing valuable franchises, as it ordered season 3 of Lilyhammer and it is also adding a final season of The Killingwhich already has a developed audience courtesy of AMC Networks (NASDAQ:AMCX).

AMC had previously canceled The Killing twice, and now Netflix will bring it back for a final farewell. In addition, Netflix will also air episodes from AMC's Better Call Saul, which is a spin-off series from the iconic Breaking Bad, within six months of its airing on cable. AMC had previously stated that Breaking Bad's season finale drew 10.6 million viewers, and thus a strong fan base is already built in. The more content Netflix produces the more valuable its business becomes, which widens the company's moat. 

Going forward
Netflix is unlikely to see headwinds from the net-neutrality law, as the economic interests of Internet service providers and Netflix are pretty much aligned. Netflix continues to invest in improving its user experience and helping viewers discover content from its huge catalog. This will lead to higher customer retention and drive more hours of Netflix viewing, which should limit churn to all-time lows.

The company laid out rosy guidance for the first quarter of 2014; it expects to add 2.25 million domestic subscribers and 1.6 million subscribers outside the U.S. The guidance implies a customer base of more than 48 million subscribers across the globe. Having a gigantic roster of paying customers by itself ensures that Netflix will continue to be a stellar performer and its stock should follow accordingly.

Find out how to profit from the ongoing transformation in entertainment
Netflix may have more upside as noted above, but it's not necessarily the best way to play this revolution. You know cable's going away. But do you know how to maximize your profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple.

Ishfaque Faruk owns shares of AMC Networks and Netflix. The Motley Fool recommends Amazon.com, AMC Networks, and Netflix. The Motley Fool owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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