Will Netflix Keep its Huge Share Gains?

Is it likely that Netflix keeps most of its share gains this time around due to its superb execution strategy?

Jan 29, 2014 at 11:45AM

Shares of Netflix (NASDAQ:NFLX) have been on a tear ever since the king of video streaming released yet another blowout quarterly report that surpassed even the most optimistic expectations for the company. The company announced that more than 2.3 million new domestic subscribers had joined its ranks in the final quarter of 2013, a huge 14% year-over-year growth, in what proved to be the company's best quarterly gain in the last three years.

Earlier on, Netflix announced that it had a long-term target to grow its domestic subscriber base by at least 400 basis points per annum, and the latest figures prove that the company is very much on course to achieving that lofty target. Investors were starry eyed at the company's ringing success and have bid up the price an astounding 20% since the results were released.

Meanwhile, Netflix continues to face tough competition from Amazon.com's (NASDAQ:AMZN) Amazon Prime, though you couldn't tell that from its consistently wild growth.

Huge international gains
Netflix's commendable growth did not just stop in its domestic subscriber base, but extended to its international segment as well. Its international subscriber base, including Latin America and Canada, saw an influx of 1.7 million new members, allowing Netflix to surmount the 10 million psychological hurdle for this segment for the first time. Overall, the company ended 2013 with more than 44 million subscribers.

Netflix's Domestic Streaming Subscribers (Thousands)

The company also recorded healthy gains for both its top and bottom lines. Its revenue for the quarter improved 9% to $1.2 billion, while its net income shot up an astounding 50% to $48 million.

Déjà vu?
Netflix shares are notorious for making massive gains in a flash, like they did exactly a year ago when they gained a monstrous 42% in a single day, the largest one-day gain in the company's history. Netflix also posted highly impressive results in the third quarter of 2013, and its shares traded up by a huge margin to almost touch $400. But then the likes of Bank of America and a host of analysts threw a spanner in the works by pointing out that the shares were grossly overvalued.

Netflix CEO Reed Hastings also said something to the same effect. Investors were spooked and the huge gains were wiped off in the space of a few weeks. So it's only natural for investors to wonder whether Netflix shares will keep their gains this time around or follow last quarter's path and tank once more. To get an idea of what lies ahead for Netflix's shares, let's have a peek at the company's core fundamentals, and if they can provide adequate valuation support.

Plenty of room to run for growth in subscriber base
The debate in media and investment circles of just how big Netflix can grow its subscriber base never seems to run out of steam. However, when you take a look at the growth curve above, it would be fair to say that Netflix is somewhere in the middle of its growth curve and nowhere near maxing out. Netflix projects that its domestic subscriber base will grow by another 2.2 million new entrants in the first quarter of 2014, while its international segment will add 1.6 million new customers over a similar time span.

Chief executive Hastings attributed the latest subscriber uptick to markedly improved marketing effectiveness, service improvements, and increased sales of Internet-connected devices. The company is still implementing these strategies, so there is reason to believe that it will meet its near-term targets.

More favorable pricing strategy
Netflix has been experimenting with tiered pricing, and the a la carte pricing strategy seems to be paying off well so far. The company started selling a $11.99 plan last spring that allows up to four members of the same family to stream simultaneously. The company is also testing a new $6.99 single-stream plan for its new customers. Mr. Hastings pointed out during the latest earnings call that the company is still probing around the edges for the best pricing structure for its streaming service and is not in any hurry to hike its prices.

Netflix has learned some hard lessons since its well-publicized Qwikster pricing mechanism that involved separating streaming services from DVD-by-mail services, leading to hefty price hikes for customers. The company now instead opts for a 'grandfathering' technique that ensures that its existing customers do not see a material hike in prices in the near term.

Losses from international operations easing out
Netflix's international operations have been in the red for some time now. The good news, though, is that these losses have steadily been declining. Last quarter, Netflix's international operations posted a $57 million loss, the lowest level in 2013. The loss is expected to come down further in the current quarter to just $42 million.

Netflix plans to kick off a substantial European expansion later in 2014. The company's recent tie-ups with European streaming companies Virgin Media and Com Hem should give it a solid footing there.

Potential headwinds
One big problem with Netflix's business model is that it's relatively easy for customers to join or leave with minimal limitations. This means that if the company makes any sudden moves that prove to be too jarring for its customers, subscribers could easily jump ship and join the likes of Amazon Prime. Amazon recently confirmed that it has about 20 million Amazon Prime subscribers globally. That translates to about 45% of Netflix's customers, which is huge by any yardstick. The fact that Amazon is now confident enough to make public the size of its Amazon Prime membership means that Netflix should now recognize it as a big threat going forward.

Netflix has been busy wrenching market share from cable TV companies such as Comcast (NASDAQ:CMCSA) and Cablevision. Comcast's subscriber base fell by 1.6% in the last year. The business, however, recently made a pleasant announcement that it has added subscribers for the first time in several years.

Comcast has been thriving even in the midst of all that talk about the death of cable, mainly through its robust Internet offerings to small businesses. There are also rumors that Netflix might enter into a partnership with Comcast in a deal that would enhance both companies' content-distribution capabilities. That is a good thing in and of itself, as I intoned in this article.

This might sound a little absurd, but Netflix also competes indirectly with DVD- rental company Outerwall (NASDAQ:OUTR), which owns Redbox. Despite all of the naysayers who have been predicting doom and gloom for DVDs and Blu-Rays, Outerwall's solid results in 2013 prove that these technologies will be around much longer than most people initially thought. Outerwall rented out 74 million DVDs in July, a record for the company.

Outerwall estimates that about 30% of its customers have subscribed to streaming services such as Netflix, meaning the rest rely exclusively on DVDs. Outerwall managed to grow its revenue by 30% in the last two years, and its bottom line by an even faster 53% clip. The company still has plenty of gas left in its tanks, and is a good investment, as I pointed out here.

Foolish bottom line
The fact that Netflix shares have now crossed the  $400 mark is a good sign that shareholders are pleased with the company's solid growth. Although it's quite possible that the shares might pull back a bit in the near term, just like they did last quarter, the company's positive moves will provide considerable valuation support and they are likely to rebound strongly. Long-term investors should hold the shares since the company is a good investment. 

Which companies are taking over your tv?
You know cable's going away. But do you know how to 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.


Fool contributor Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Amazon.com 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.

4 in 5 Americans Are Ignoring Buffett's Warning

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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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