3 Reasons to Love Netflix

The same company that earned its recession-resistant wings during the economic downturn is lacing up its running shoes now that the consumer-spending climate is showing signs of life.

Netflix (Nasdaq: NFLX  ) delivered another monster quarter last night. Revenue climbed by 24% to $444.5 million, in line with expectations. Things got better on the way to the bottom line, as gross margins expanded from 35% to 38% and the DVD-rental specialist's profit soared by 36% to $0.56 a share. Analysts were settling for net income of only $0.45 a share.

However, there's more to Netflix than just market-thumping consistency. Let's delve deeper into Netflix's quarter by analyzing the secrets to the company's success.

1. The Netflix model works
There are now nearly 12.3 million subscribers for the Netflix service, 31% higher than the audience of movie buffs that Netflix commanded a year earlier. The fourth quarter was special, as it tacked on nearly 1.2 million net new members to the company's rolls.

Churn clocked in at 3.9% during the period, and even that figure showed both sequential and year-over-year improvement. I realize that shedding an average of 3.9% of its user base a month may seem high when compared with services that require hefty initial investments or lengthy contractual commitments, but it's actually an impressive feat given the click-easy simplicity of suspending or canceling the movie-delivery service.

2. Netflix is an oasis in the digital video desert
You're no doubt seeing a glut of stories about Apple's (Nasdaq: AAPL  ) iPad today. One of its biggest selling points is that the larger screen may finally give Apple the killer tool it needs to make the same kind of dent in digital video that the iPod made in digital music.

Sure, Apple has been selling and renting video through iTunes for years, but it doesn't appear to be a game changer for movie studios. Apple TV's lack of success is anecdotal evidence that couch potatoes don't associate Apple with digital video.

Amazon.com (Nasdaq: AMZN  ) and Blockbuster (NYSE: BBI  ) are no slouches in online retail and DVD rental, respectively. But even their attempts to become leaders in digital video have been brutally uninspiring.

Apple, Amazon, and Blockbuster have disappointed because they are still trying to move piecemeal rentals and sales. Netflix includes digital streaming at no additional cost to its unlimited DVD subscriptions, at a time when even premium buffets aren't readily available elsewhere from the heavy hitters.

Why is everybody else so stubborn or stupid? Their ignorance is Netflix's gain.

3. Netflix's moat is large enough to overcome its shortcomings
Last night's report wasn't perfect. Average revenue per user continues to shrink. Online streaming is a great retention tool, but it's also an incentive for cash-strapped subscribers to downgrade to cheaper plans that let them take out fewer discs at a time.

One of the questions during last night's conference call was about whether average revenue per user is on an inevitable path to $8.99 a month, the cheapest priced plan that includes unlimited streaming. Netflix simply responded that 10% of its users are paying $2 more a month for Blu-ray access. Rather than seeing Netflix concede the point, I would have preferred to hear the company drum up the potential of incremental revenue streams, either through international expansion or through the addition of video games to its service. I would have even welcomed a sound argument for pricing elasticity. In the company's defense, though, subscriber acquisition costs also continue to inch lower.

I'm also not convinced that the move to delay Time Warner's (NYSE: TWX  ) new releases for 28 days -- in exchange for cheaper DVD prices, greater availability, and broader online licensing of older titles -- will be worth it.

Netflix claims that less than a third of its shipments are for new releases, but we're still talking about managed dissatisfaction. Improving the streaming product at the expense of the mail-order model is a risky move, since only 48% of Netflix subscribers streamed at least 15 minutes of video this past quarter.

Netflix claims that it hasn't heard any subscriber complaints about The Invention of Lying, the first title to get bumped, but just wait until subscribers get hit with a four-week freeze on a title that didn't bomb with less than $20 million at the domestic box office. When The Blind Side is available at Blockbuster, through Comcast's (Nasdaq: CMCSA  ) video on demand, or even at Coinstar's (Nasdaq: CSTR  ) Redbox kiosks for a buck daily, we'll see whether the perceived value proposition of Netflix isn't what gets blindsided.

Despite these knocks, Netflix continues to grow -- and that's the ultimate endorsement. It expects to close out 2010 with 15.5 million to 16.3 million subscribers, adding more net new subs than the 2.9 million it tacked on last year. It sees revenue and earnings growing by as much as 26% in 2010.

It's hard to bet against the one company that's doing nearly everything right in digital video's convergence -- warts and all.

What did you think about last night's earnings report? Share your thoughts in the comments box below.

Amazon.com, Apple, and Netflix are Motley Fool Stock Advisor selections. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz has been a Netflix shareholder and subscriber since 2002. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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