Is Netflix A House Of Cards?

With competition from Time Warner's HBO and Amazon's Prime Instant Video, is Netflix capable of delivering sustainable long-term growth?

Mar 1, 2014 at 10:00AM



Netflix (NASDAQ:NFLX) often finds itself at the center of much investor debate, primarily due to its sky-high stock price of $451 per share and rich valuation of 59 times forward earnings. However, its closest peer Amazon (NASDAQ:AMZN) is trading at a somewhat similar price of $346 per share and valuation of 83 times forward earnings.

What stands out is that Amazon is more expensive than Netflix. This might be justifiable given that Amazon is a more diversified company. Netflix relies solely on content, and if it falters in this area, then Netflix's sky-high stock price could soon be met with gravitational forces. 

Binge viewing
Netflix offered differentiation by releasing all 13 episodes of its hit series, House of Cards, all at one time. This led to binge viewing. According to Procera Networks (which provides Internet traffic management for broadband providers), approximately 16% of Netflix subscribers watched House of Cards on its release date this year, which was much higher than last year's figure of just 2% of Netflix subscribers. 

Of course, the success of Season One has a lot to do with the increased interest in Season Two, but for investors, the facts are the facts, and the increased demand is a positive. House of Cards Season Three will also begin production soon. Given the high interest and ratings for the series -- which scores 9.0 of 10 on IMDb -- that percentage for first-day viewing is likely to increase even more next year.

Global growth
What might surprise some readers is that House of Cards is also performing well in China. Yes, China, the country where censorship is high, and which only allows 34 foreign films to be screened per year. The Chinese government probably doesn't mind the "democracy is a farce" angle of House of Cards being aired to its citizens. (NASDAQ:SOHU) made it possible for Chinese citizens to watch House of Cards after it purchased exclusive rights to the series in Mainland China. This was potentially a very wise move by Sohu. It's a gamble, but if American content sees less censorship in China down the road, then Sohu will have a big head start.

House of Cards isn't an exclusive-content one-trick pony for Netflix. Its Orange is the New Black series has also been popular, scoring a solid 8.5 of 10 on IMDb.

Looking at the performance of an individual series is fun, but what matters most to investors is growth. In the fourth quarter, Netflix was added to 2.3 million households. It also added 1.7 million subscribers in Canada and Latin America, and 10 million subscribers internationally. At the end of 2013, it had a total of 44 million subscribers.

Fourth-quarter revenue and net income came in at $1.2 billion and $48 million, respectively. These were both sequential improvements over last quarter: $1.1 billion in revenue and $32 million in net income.

In addition to exposure in China and growth in Canada and Latin America, Netflix plans on substantial European expansion next year.

So ... is there anything for Netflix to worry about?

Potential future threats
It would be complicated for Time Warner's (NYSE:TWX) HBO to become a streaming-only service due to increased costs. However, if HBO found a way to pull it off, it could present a threat to Netflix.

House of Cards and Orange is the New Black rate well, but they don't compare to HBO's biggest hits. For instance, Game of Thrones, The Wire, and The Sopranos sport extremely high IMDb ratings of 9.5, 9.4, and 9.3, respectively.

Put simply, HBO knows how to deliver top-notch content. As long as it possesses that skill, it's a potential future threat to Netflix. Since cord-cutting is becoming more popular, anything is possible.

Amazon Prime claims to have "tens of millions" of members, but it's clear that Netflix and Amazon Prime Instant Video can co-exist without one hurting the other too much.

The Foolish takeaway
Netflix's stock is expensive. Therefore, if the broader market were to correct, Netflix would likely take a significant hit. The other threat would be a changing industry landscape, but that likely wouldn't take place for a while. For now, Netflix's underlying business is strong and seeing continuous growth. Conclusively, Netflix is not a house of cards. However, due to a high valuation, it is still somewhat high-risk. Please do your own research prior to making any investment decisions. 

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends, Netflix, and The Motley Fool owns shares of 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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