On the surface, Netflix (NASDAQ:NFLX) looks like the underdog in a Blockbuster (NYSE:BBI) world. But when all is said and done, you get the feeling that Netflix might just have what it takes to get to the big show.
Yesterday afternoon, the online mail-service DVD rental company reported a 77% year-over-year jump in third-quarter revenues to $72.2 million, showing a GAAP profit of $3.3 million or $0.10 per diluted share. Meanwhile, cash flow from operations almost doubled to $22 million.
But several other things stand out. First, the cost of growth is dropping. Second, the benefits of Netflix's online model are starting to show up in the margins. And most importantly, there is plenty of free cash flow.
As highlighted two weeks ago, Netflix's subscribers jumped 13% sequentially to 1.29 million. Just as importantly, the churn rate -- or subscriber loss -- fell to 5.2% in the quarter from 7.2% in last year's quarter. On top of that, the acquisition cost of those new subscribers fell from $33.57 to $31.81 over the same period.
And while gross margins are still low compared to brick-and-mortar rental joints, Netflix's net margins actually run higher. As gross margins improved to 46.5%, net margins came in at 4.6% -- better than Blockbuster, and comparable to Hollywood Entertainment (NASDAQ:HLYW). But excluding stock-based expense, Netflix showed a net margin of 8.4%.
Free cash flow, in its eighth consecutive positive quarter, also grew 36% to $7.9 million, for a healthy 11% margin.
Not too long ago, there were a bunch of Netflix skeptics. In the face of competition from Wal-Mart (NYSE:WMT) and Blockbuster as well as a perceived future threat from Amazon (NASDAQ:AMZN), I'm sure there still are.
But since Rick Aristotle Munarriz profiled the company in the November 2002 TMF Select (now Hidden Gems) at $10.90 per share, the stock has just about quintupled. Since David Gardner picked it in Motley Fool Stock Advisor in June, Netflix is up, oh, 150% or so. And since Netflix reported earnings yesterday, the stock is up 17% to over $52 a share.
Fully diluted, Netflix boasts a $1.6 billion market cap, or about 70 times its $22.3 million in trailing free cash flow. The stock's value is up for debate, but with Netflix's spectacular growth, solid cash flows, nifty brand, and cult following, there is at least one less skeptic today.
Jeff Hwang doesn't own shares of Netflix -- yet. He can be reached at [email protected].
