Down More Than 30%, Is Now the Time to Buy Netflix?

If you want growth, Netflix has it in spades. But competition is increasing from all angles, even from seemingly marginal players like World Wrestling Entertainment. But don't let this fool you.

May 16, 2014 at 10:04AM

With Netflix (NASDAQ:NFLX) down more than 30% from its 52-week high, some investors might be looking for an opportunity to catch this falling knife. With the company reporting earnings recently, there are at least three reasons to believe that the recent drop may be just the opportunity long-term investors are looking for.

Contributing to future growth
Netflix has maintained for a while that it expects to fund its international growth plans by its cash flow from domestic streaming and DVDs. While it's true that Netflix's DVD business is still losing customers, the company's domestic streaming business is helping to offset this decline.

However, on the domestic front, the streaming business is getting much more competitive. For one, Amazon.com recently signed an exclusive deal for several HBO shows. Given that HBO has been named by Netflix as one of its primary competitors, this deal between Amazon and HBO would seem to be a direct shot at Netflix.

In addition, there is yet another new streaming service competing for viewership, albeit within a small niche, with Netflix. This service comes from World Wrestling Entertainment (NYSE:WWE). The WWE Network is priced at $9.99 per month, and it signed up 667,000 domestic subscribers in just the first 42 days.

What is unique about WWE Network is that the company owns all of the content. This puts WWE in a significantly better competitive position for wrestling content than Netflix or anyone else. WWE also offers a unique value proposition to its subscribers since they receive every pay-per-view event included in the WWE Network.

Given that WWE suggests that the company has about 80 million "active" fans of its programs, it seems likely that the less than 700,000 current subscribers are just a small part of the network's potential.

Even with these new challenges, Netflix is still seeing strong domestic streaming growth, and even more important, the company's contribution margin is growing. In the last three months, Netflix's domestic contribution margin rose to a new high of 25.2%. With the company's plan to increase the price of domestic streaming-only plans from $7.99 to $8.99, this margin will continue to climb.

Winning by breaking even
It's no secret that Netflix's biggest opportunity lies with its international expansion plans. There were two significant surprises from the company's international division in the last quarter. First, subscriber growth came in at 86%, year over year. Second, the company cut its contribution margin loss in half compared to last quarter, and it announced that existing international operations would break even this year.

On a relative basis, Amazon and WWE have very different business models on the international front. Amazon witnessed media sales growth overseas of just 4%, which was the slowest growth rate in the last five quarters. WWE expects to expand its WWE Network overseas, yet in the last three months, it staged no international events.

Though Netflix's next international expansion will hurt results in the short term, it's just the next logical step in the company's progress overseas.

Flow like no one else
Finally, Netflix is putting on a clinic when it comes to growing core operating cash flow, or net income plus depreciation. On one hand, WWE Network caused the company's operating cash flow to turn negative compared to last year. While Amazon's 40% increase in core operating cash flow over the prior year looks very strong, it's relatively slow-growing compared to Netflix.

On a year-over-year basis, Netflix just reported that core operating cash flow increased by more than 340%. It's true that Netflix has significant expenses due to content acquisition now and in the future. However, the company is able to write off a tremendous amount of these expenses as it amortizes its library.

Foolish final thoughts
In conclusion, Netflix's domestic streaming business is growing and should continue reporting stronger contribution margins. The company's existing international operations are expected to break even before some investors might have expected.

Investors who are worried about Netflix's big content expenses in the future need to look no further than the company's huge operating cash flow growth. With the stock down significantly from its highs, this could be a good opportunity for long-term growth investors.

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Chad Henage owns shares of World Wrestling Entertainment. 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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