Netflix (NFLX 4.17%) has been among the most volatile and intensely debated stocks on the market over the last few years. Shares hit a peak in 2011 near $300 before unraveling as the company suffered a customer backlash for separating its streaming and DVD-by-mail services -- charging users $8 per month for each, instead of $8 combined.
Since bottoming out near $50, however, the stock has soared as the streaming model has taken off. It nearly reached $500 last summer before falling to about $320 today. With its fourth quarter earnings report set to come out this week, I think that Netflix stock is poised for another surge and well-positioned for long-term growth. Here are several reasons why:
International expansion will soon pay dues
Netflix launched in France, Germany, Belgium, Austria, Switzerland, and Luxembourg in September, adding an addressable market of 66 million households to its base. The immediate effect of that launch is to expand its contribution loss to a projected $95 million as a result of new content and other expenses from the launch, but with the legal battles now in the past, those markets should help add to the bottom line as membership grows. Notably, the company is now profitable on aggregate in the other international markets it has entered, starting with Canada four years ago and onto The Netherlands one year ago. In Canada, its oldest foreign streaming market, contribution margin nearly matches the U.S. market.
Netflix will soon have 20 million international members, and revenue from abroad nearly doubled in the last year. All signs point to profitability in foreign markets, and there is still the launch in Australia and New Zealand coming up in March. Several other markets awaiting entry include Spain, Italy, Japan, Korea, and others. Combined, these markets enhance the value of Netflix's subscriber model, because each additional member becomes more valuable than the previous one.
Rival industries are beginning to crumble
Just as the way we consume music, books, and other print media has drastically changed in the last 10 to 20 years, the way we watch television and movies is now transforming.
Pay-TV subscriptions fell for the first time ever in 2013, and though the decline was small, at just 251,000 subscribers or less than 1%, cord-cutting likely hastened in 2014, given the response by CBS, HBO, and others who have launched Netflix-style stand-alone streaming services.
As cable wanes, services like Netflix will only grow more popular. The future of TV is likely one where users have several subscriptions to Internet TV providers like Netflix and choose what to watch and when to watch it.
Similarly, movie theaters had their lowest ticket sales in nearly 20 years last year and their worst sales per-capita since record-keeping began in 1980. Though there are several theories about why performance was so poor, the increasing appeal of home entertainment because of options like Netflix was likely a major factor.
This is probably the best deal in home entertainment
At $8 a month for current subscribers and $9 for new ones, a month of Netflix costs less than a bucket of popcorn and a soda at the movies. In the days when Blockbuster ruled the home video market, Americans would happily make two trips to the video store and fork over $5 for a single movie on VHS. Cable subscribers pay an average of $90 month, much of it going to channels they don't watch. You could get nearly a whole year of Netflix at that price.
Netflix claims that its 53 million members enjoy more than 2 billion hours of movies or shows per month, all with no advertising, meaning the average subscribing household consumes about 40 hours per month. At a price of $8, that comes to just $0.20 an hour.
The company has tested its pricing power in the past with mixed results, most notably when it separated the DVD service from streaming. Though seen as a debacle at the time, the results since have redeemed Netflix's management. Last summer, it raised prices for new subscribers by $1 to $9 and added about a million new members in Q3, the first full quarter after the price hike. Subscription additions were below forecast from the prior year, and management cited the slightly higher prices as the primary cause for the slowdown in growth. Still, subscribers grew about 3% sequentially in a seasonally slow quarter, and Netflix is projecting growth of nearly 2 million members, or 5%, in the fourth quarter. Netflix also plans to implement a $1 price increase on all U.S. members in the middle of 2016.
Compared to competitors like Amazon Prime and Hulu Plus, Netflix has a much larger content library and more original shows at a nearly identical price tag. No one knows how much a streaming subscription to HBO, which Netflix considers its closest rival, will cost, but the average price for HBO with a cable subscription is about $15. HBO is unlikely to undercut that price. Considering its competition, Netflix appears to be underpriced, and should be able to raise prices as Internet TV goes mainstream.
The price is right
Netflix shares have fallen nearly 25% since its disappointing third quarter report, but its prospects appear to be stronger than ever. Based on conventional multiples, the stock is still expensive, but Netflix is by far the largest player in video streaming, an industry that's set to dominate home entertainment the way cable has for a generation. Profits are still growing quickly with analysts expecting near 40% EPS growth next year, and its subscriber model should ensure expanding margins as membership increases. Its management team is smart and trustworthy, having guided the company through not one but two disruptive innovations, while maintaining its industry leadership.
With its ongoing international expansion, an expanding content library, and its first original movie set to hit screens, 2015 is gearing up to be a great year for Netflix. 2016 should be even better.
