There's something special about Netflix (NASDAQ:NFLX). The stock has more than doubled over the past six months, but it's not just about recent gains. I've owned shares in this brilliant company since 2002, which happens to be as long as I've been a satisfied Netflix subscriber. That's why I'm going to warn you that I'm going to be biased here. It's why I'm going to make sure that I stick to the facts. The moment I start gushing without fundamentals to back me up, do us both a favor and give me the Chinatown slapdown with a signature red Netflix mailer.
How good is Netflix? Well, the DVD rental specialist grew its revenue by 86% last year. It's looking to grow the top line by at least 34% in 2005 as it goes from 2.6 million subscribers to a whopping 4 million members by the end of the year. The company is looking to exceed 5 million subscribers sometime next year, with the goal of landing 20 million subscribers in five to seven years.
The company's growth has come despite a slowdown in the DVD market. Movie studios are warning about their retail sellthrough rates, and brick-and-mortar disc renters such as Blockbuster (NYSE:BBI) and Movie Gallery (NASDAQ:MOVI) continue to post rental revenue declines at the store level.
Where are all of these customers going? That's right: Netflix. It's not just the online convenience of an Internet-based platform. It's Netflix. How else can one explain why a shrewd cost-cutter like Wal-Mart (NYSE:WMT) decides to wave the white flag of surrender and shutter its wannabe online-rental venture, referring its tiny subscriber base to Netflix? How else can one explain why Amazon.com's (NASDAQ:AMZN) entry into the stateside DVD rental market has been pending since last year, clearly holding back because only Netflix has been able to turn a profit in this difficult climate? How else can one explain why Blockbuster tried to beat Netflix on price, only to see Netflix's lead widen and its creditors give it the mother of all staredowns?
Netflix reigns because it ramped up in a hurry. It quickly built out a system of regional distribution centers to assure that the vast majority of the country can receive fresh DVDs overnight without paying a dime in postage. Netflix foots that bill both ways, and that's awfully generous when $3 gallons of gas make the conventional Blockbuster night as costly as it is burdensome.
Yes, Netflix will eke out only a small profit this year, but I think this experience of fretting over Amazon and waging a price war with Blockbuster has made Netflix an even smarter -- and stronger -- company. The turmoil forced Netflix to think more efficiently by optimizing at both ends of the business model. Over the summer, Netflix hired an interactive entertainment ad executive from Time Warner's (NYSE:TWX) AOL to launch an ad sales program. That's a no-brainer. It's sending mailers to 4 million households with disposable income to burn.
Its fulfillment costs are growing at a slower clip than sales. Fulfillment costs rose by 22% this past quarter while sales clocked in 38% higher. That margin-widening measure is a testament to Netflix's commitment to running a tighter ship, as well as the welcome trend of folks renting entire seasons of television shows on DVD. That finds the average subscriber holding on to their rentals longer, a good thing for the company's variable cost structure.
In recent months, more innovations have crept into the Netflix fabric. It's now giving its subscribers the option of purchasing overstocked titles at prices more favorable than its aged inventory was being sold for elsewhere. The company's potent recommendation software, where members are given worthy DVD picks based on previous rental and flick-rating patterns, received a viral upgrade when Netflix rolled out a feature that allows subscribers to share their picks with family and friends.
Netflix has done it right so far. It has vanquished the competition by sticking to the basics. One can only fathom the greater gains that are just waiting to be had as the company grows sixfold over the next half-dozen years and expands its turf.
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David Gardner first recommended Netflix to Motley Fool Stock Advisor subscribers two summers ago at a split-adjusted price of $11.31. Amazon.com is also a Stock Advisor pick. What stocks are piquing David's interest these days? Find out with arisk-free trial subscription.
Fool contributor Rick Munarriz has been a Netflix investor -- and subscriber -- since 2002. He does not own shares in any of the other companies mentioned in this tournament match.
