When consumers buy a house, they take on debt that will take decades to pay off, but they gain the stability of knowing where they will live long term. Mortgage lenders look at their ability to generate income, their history of paying their debts in a timely fashion, and the likelihood that they will continue to do so. While this is by no means an apples-to-apples comparison, it provides a useful example of how streaming pioneer Netflix, Inc. (NFLX 1.71%) is building not a house, but a library, and how it will continue to generate additional subscribers for years to come. It's also the reason I think Netflix is a top stock to buy now.
More quality programming = more subscribers
Consider the original model that Netflix used to build its business. It would buy stacks and stacks of movies on disk and ship them via little red mailers to consumers everywhere. The theory was that once the company owned those disks, they would be watched by legions of subscribers until they were paid for, then subsequently generate a profit as they became part of the company's massive library.
Netflix originals are leading to a surge in subscriber growth. Image source: Netflix.
The model Netflix uses now is not so very different. Rather than buy stacks of disks, it invests in original content, which is then owned by Netflix for all eternity and becomes part of its library of content. As this library expands and grows over time, Netflix will be able to scale back on the amount of newer content it produces. A mature library will provide subscribers with a mix of newer programming and older favorites that will be much less costly to maintain. Netflix is in the process of building out its library all around the world, which will accelerate its international subscriber base. Netflix plans to spend $6 billion on content this year alone.
The company didn't always own its content. When Netflix first began producing original series, it licensed the content, rather than owning it. Some of the original programming that is inexorably linked to Netflix falls into that category: House of Cards is owned by Media Rights Capital, Orange is the New Black is co-owned by Lions Gate Entertainment and Tilted Productions, and Daredevil and Jessica Jones are both owned by Marvel parent Walt Disney. It wasn't until 2015 that Netflix began creating content that it intended to keep.
The world is its oyster
If you have any doubts about whether Netflix is on the right path, a review of member increases should put those to rest. Year-over-year subscriber growth has exceeded 20% in each of the past eight quarters, and has grown 24% on average. In the most recent quarter, subscribers grew by 25% year over year, and total international subscribers exceeded domestic subs for the first time, as the company's original content continues to attract new members.
The financial results were equally impressive. Revenue grew to $2.78 billion, a 32% year-over-year increase, and earnings per share grew to $0.15, up 67% over the prior-year quarter. This is likely just the beginning, as Netflix expands its local content for international subscribers.
Building out for future success
Investors looking for assurances about how the company's international expansion will play out need look no further than its more mature domestic market for guidance. Netflix's domestic contribution profit (revenue less cost of revenue and marketing expenses) exceeded 37% of its revenue for the most recent quarter, compared to a contribution loss for its international operations. As international subscribers continue to ramp up, this metric will become positive and begin to contribute to Netflix's profitability.
Netflix bears tend to point to the growing content spend and negative cash flow as reasons they believe that the company won't succeed. I take a different view, seeing both as a necessary first step to the company's worldwide domination.
