Three Reasons Netflix Can Keep Growing

Netflix's dream run seems set to continue. But will Time Warner's HBO and Amazon prove a stumbling block?

Apr 7, 2014 at 6:00PM

In the fourth quarter, Netflix (NASDAQ: NFLX) reported earnings that were more than six times higher than what the company earned last year. The company beat revenue estimates by $10 million, improved its contribution margin by about 400 basis points, and grew the number of U.S. subscribers by 14% on a year-on-year basis. Despite its success, many bears think Netflix is well into its growth stage. This is primarily because the companies' valuation of 49 times FY 2015 estimated earnings. But it is a massive misconception to think Netflix cannot sustain its growth. For one, the streaming video business as a portion of entertainment viewing is still in its infancy.  Also, Netflix has signed a deal with Comcast that should bring in more subscribers looking for faster streaming speeds. In addition, Netflix has a strong pipeline of content that will draw more viewers.

Growth prospects of video streaming
While Netflix got its start partially by mailing DVDs to customers, the future of the company lies in the video streaming business. It accounted for over 80% of its $1.17 billion revenue in the last quarter. Mintel, another research firm, recently carried out a survey on the streaming video sector. It found that the sector was still in its early stages. 46% of people living in the U.S. used a subscription video account. It is likely that they will continue to use this service due to industry trends. Mintel expects total sales to reach $16.7 billion by 2018. This would benefit Netflix, which is currently found in a quarter of U.S. households.

The Comcast agreement
Netflix has agreed to pay Comcast to ensure that its customers can watch its content free of problems. Comcast already has nearly 21 million broadband customers. The number will grow to about 30 million by December if it wins  approval to purchase Time Warner Cable If Netflix's video streaming quality doesn't improve on Comcast, it risks alienating its own subscribers. The discontent could undercut Netflix's subscriber growth.With the Comcast deal, Netflix retains its subscribers.In the long term, Statista, a research firm, forecasts  the wireline broadband availability in the United States is estimated to cover 95.7 percent of the U.S. households in 2015.  Clearly, Netflix  still has a room for growth in the sector.

Ahead of the pack
Netflix's experience with its contents gives it a significant advantage over its rivals. It has a strong pipeline of content that will draw more viewers, which will in turn improve the company's top line. In the fourth quarter of 2012, Netflix earned just 13 cents per share. After millions of viewers watched its movies and all the other content, Netflix's earnings per share in the last quarter were $0.79.  Netflix's  content initiatives could enable the company meet its net income target of $48 million for the present quarter.

Competitors
Time Warner
's (NYSE: TWX) HBO for a time was not a direct competitor to Netflix. However, Netflix's recent success with its streaming original shows puts it in a competition with HBO. Also, HBO presents a threat not only to Netflix in connection with where viewers get their entertainment, but also to the content that Netflix is able to stream. The cable network can secure exclusive contracts that limit the content that Netflix can offer.  According to Cisco, global online video users are expected to grow from 1.1 billion in 2012 to nearly 2 billion by 2017 -- a compound annual growth rate 13.2 percent. HBO made $4.9 billion from subscription fees in 2013. It wants more improvement by gaining a sizable share of this market.

Recently, Amazon.com (NASDAQ: AMZN) tested its second round of original productions. The first round led to 1 or 2 shows getting full seasons. Since the trend favors the growth of the video streaming business, Amazon will be in a position to make a run at Netflix. Though it trades at a somewhat similar price with Netflix at $342 per share, Amazon has a valuation of 81 times forward earnings. In other words, it is more expensive than Netflix. But the number of U.S. digital TV viewers will reach 145.3 million in 2017, up from 106.2 million in 2012, according to eMarketer. Amazon clearly has reasons to improve its streaming content to gain a significant share of the market.

Foolish takeaway
In the fourth quarter, Netflix's revenue and net income came in at $1.2 billion and $48 million respectively. In addition, it has gained a lot of experience marketing its original content. The video streaming business is set to show more growth, and the company's deal with Comcast should bring in more subscribers. As a result of this, I believe Netflix is set for more growth in the near future.

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Mark Girland 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.

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