The third quarter's earnings season for tech stocks is kicking off with a bang, thanks to Netflix (NASDAQ:NFLX) coming through with better-than-expected financial results after Tuesday's market close. Revenue, earnings, and subscriber counts landed well ahead of Wall Street's and Netflix's own public projections, sending the shares initially higher on Wednesday in an otherwise dreary trading day.
Netflix is now the undisputed champ when it comes to premium streaming video, but it wasn't always that way. A decade ago, this was still a company relying on the physical rental of DVDs by mail. This throwback business is still alive and kicking at Netflix, and while the number of accounts continues to contract -- we're down to 2.828 million subscribers on this format -- it's still a vital part of Netflix's heritage and possibly its future.
Netflix is clearly a digital video juggernaut these days, and it's the reason why the stock has been the S&P 500's top performer since 2013. However, we can't ignore more than 2.8 million people receiving DVD and Blu-ray disc rentals in the mail. The original model lives on, even though the business has declined to the point where it's now accounting for a little more than 2% of its total revenue and subscriber base.
CEO Reed Hastings saw this coming shortly after the number of customers on its DVDs-by-mail plan peaked near 20 million in 2010.
"We expect DVD subscribers to decline steadily, every quarter, forever," he mentioned in an early-2012 earnings call, responding to a question asking if DVD rentals would bounce back that year.
Hastings was right. DVD rentals didn't bounce back that year or any year. There has never even been a sequential uptick. This is by most accounts a dying business, but it's also an important piece of the perpetually evolving story at Netflix.
Netflix isn't likely to get rid of its DVD service anytime soon. There are still homes that don't have hearty enough connectivity to effectively stream digital content, and the platform also has a lot of movies and shows that will never be available for the other 98% using the service's growing digital catalog.
There's also no reason to kill off a service that is ridiculously profitable. Despite shrinking to the point at which it's seemingly an afterthought, Netflix's mail-order business accounted for 4.5% of the total contribution profit. The streaming business may be what's scaling these days, but its contribution margin of 39% in the U.S. and 17% internationally will probably never approach the 58% that it's scoring with its physical rentals.
On the surface, Netflix's mail-order endeavor might seem like a bad tattoo, but there's art in this permanent ink. Netflix might have shuttled its disc-renting customers away from its namesake domain to its DVD.com hub years ago, but this is a platform that could come in handy in the future if it ever cracks a large enough foreign market where the streaming infrastructure isn't firmly in place. It's also a great place to point its growing stateside streaming subscribers to when they want access to a hot TV show or Oscar-winning movie that's not available on Netflix.com. The tune might change the moment that the disc-renting base shrinks below profitability, but for now, the two-percenters at Netflix will continue to matter.