Online video giant Netflix (NFLX -0.63%) is sitting pretty with more than 40 million subscribers. Netflix stock was the second-best performer in the U.S. market in 2013, with shares up almost 300%. But based on the booming growth in subscribers in the domestic and international markets, and its growing portfolio of original and exclusive content, Netflix still has solid upside in 2014.
Domestic has room to run
Netflix's standard monthly subscription service offering, priced at $7.99, represents a great bargain for consumers. Considering the low price point and an increasingly wide breadth of content, including a great mix of premium and original shows and a superior user interface, it is reasonable to believe more U.S. households will subscribe to Netflix. The company has recently begun testing a variety of pricing plans that start as low as $6.99 a month for a single streaming plan.
The company had 31 million domestic subscribers at the end of the last quarter. The company's business model commands huge operational leverage, because most of the content costs of Netflix are primarily fixed costs. As a result, a large subscriber base will drive the company's contribution higher and boost its earnings per share.
Netflix's management has stated that the company's U.S. opportunity stands at 60 million to 90 million. Based on the lower end of that guidance, Netflix will be able to rope in another 30 million new domestic users. Netflix how has more U.S. subscribers than Time Warner's (TWX) HBO. While HBO doesn't disclose its subscriber numbers, estimates from research firm SNL Kagan stood at 28.7 million at the beginning of 2013. And HBO is adding roughly 50,000 subs a quarter, while Netflix added 1.3 million domestic subs in its third quarter.
Of course, there are other subscription players. Ad-supported Hulu has 5 million paying subscribers and Amazon.com's Prime service has more than 20 million members. Netflix offers a much better user interface and more content compared to its competitors, which should keep its domestic subscriber base growing, and its churn rate should drop to a record low. Netflix is extracting incremental revenue from a small group of consumers through tiered pricing plans, like family pricing at $11.99 for four simultaneous streams.
Netflix Originals
Netflix had a fantastic 2013 based on its very successful original content strategy. The company's shows like House of Cards and Orange Is the New Black have been instrumental in growing Netflix's global brand value.
Management stated it will increase its original content budget from 10% of its total content expenditures to much higher levels, to the tune of 15% to 20% in 2014. Netflix is spending close to $3 billion a year for content, and if the company allocates 20% of that toward developing high-quality originals, it will have a much more robust original library. The development of more Emmy-winning shows will attract newer audiences to Netflix, and give the company more pricing power.
Amazon and Hulu are developing their own originals, but Netflix has been a lot more successful in building high-quality franchises. The company will be unveiling season two of the critically acclaimed House of Cards in February. And a much larger original library similar to Time Warner's HBO will lay the foundation for possibly raising prices modestly to $8.99 or $9.99 a month, and still remain a valuable service and a bargain for consumers.
International growth and profitability
Netflix has been growing its international business by reinvesting the profits from its domestic DVD and streaming business. As a result, the company now has 9.2 million international subscribers in roughly 40 countries. The rapid growth in domestic contribution profits will enable the company to invest heavily in its international segment, which is a gigantic addressable market.
And the company hasn't even launched in a number of large markets, such as Russia, China, and India, which makes it reasonable to believe that its international user base could one day surpass its domestic subscriber count easily.
In terms of profitability in the international market, Netflix should continue to lose money in the near term as it is investing heavily in building large localized content libraries for each country/region. The only profitable country in the international segment is Canada, and as other markets mature, Netflix's profitability should get a major boost.
The takeaway
Netflix can easily grow its penetration rates in the U.S., and gain a lot of new members in its international segment. The company's management team has done a fantastic job of widening its moat and executing on its long-term vision. Netflix has a number of years of double-digit revenue growth ahead, and will receive substantial tailwind from secular consumer trends. Taking all these factors into account, Netflix seems headed higher in 2014.
