Nearly three years ago, Netflix (NFLX 1.74%) CEO Reed Hastings angered many fans when he announced the company's DVD delivery business would be split from the video streaming segment into a service called Qwikster. Angry customers revolted, resulting in canceled memberships and a plummeting stock price. However, many astute investors jumped in and picked up a high-quality company at a discount.
What happened over the next three years was simply astounding. After Netflix briefly touched a low-water mark in the mid-$60s per share, it initiated a 600% upward climb to its current price, near $430. And while some of the initial drop was due to overly bearish investors, much was due to Netflix's operations themselves. Moving forward, the next leg of growth will be provided by Netflix's international operations.
International's short history
Netflix's international business has a rather short history. Starting by moving to Canada in 2010, the company quickly added a host of countries to its international streaming roster: the U.K., Ireland, Norway, Denmark, and Mexico, among others. Today the company is in more than 40 countries, with more than 54 million paying members. Of those members, 24% are international streaming members.
And when it comes to paying-member growth, the numbers look even better:
| Metric | International Steaming | Domestic Streaming | DVD |
|---|---|---|---|
| Paying members: June 2012 | 3,024 | 22,686 | 9,194 |
| Paying members: June 2014 | 12,907 | 35,085 | 6,167 |
| Total growth | 326.8% | 53.4% | (32.6) |
Figures in thousands. Source: Netflix 10-Qs.
The company appears to be ramping up its international marketing efforts. For example, in the last quarter, 46.4% of Netflix's marketing costs were spent internationally -- that's more than 500 basis points higher than the prior year's quarter, when the number clocked in at 41.3%.
The fading legacy business
Although Reed Hastings recanted on the idea of Qwikster --a separate site-- the company still went through with its earlier plans of charging separately for DVDs and streaming. And the DVD-by-mail part of the business isn't doing too well. Over the last two years this service has lost a third of its paying members. In that time, the company essentially spent no money on marketing the service.
However, the company continues to benefit from the DVD service. A rather important metric for Netflix investors is contribution profit -- an operating measure that shows net revenues after the costs of sales and division marketing expenses.
X-Axis denotes quarter-ended date. Source: NFLX 10-Qs. Figures in thousands.
Although the DVD division contributes less and less to the overall contribution profit, dropping from being the leading contributor in March 2012 by adding nearly $150 million to contribution profit to adding less than $100 million in the last quarter, in the end the division continues to offset the contribution loss from Netflix's international operations.
However, based upon the growth trajectory, soon Netflix's international operations won't need an offset. The international business continues to grow members at a rapid clip and reported only a $15 million contribution loss last quarter. It is very possible that Netflix will report a contribution gain from international next quarter.
Final Foolish thoughts
Netflix continues to defy skeptics by keeping that top line growing. And the company appears to have a strategy for sustaining this streak. Netflix recently announced it will expand to a handful of European countries by year's end, including Germany and France. Investors would be wise to continue to closely monitor the company's international operations, as that's where the growth will be going forward.
