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Up 30% in a Month -- 3 Reasons to Expect More From Netflix

By Chad Henage – Feb 18, 2014 at 12:15PM

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An improving margin in the domestic streaming business, coupled with investors' better understanding of international opportunities, could mean that Netflix stock continues its run.

To say that investing in Netflix (NFLX -0.07%) isn't for the faint of heart is an understatement. However, the company seems to have found its footing after several brutal price swings that saw the stock drop from more than $300 a share to less than $60. With shares hitting new highs, some investors might believe they have missed the boat. However, there are at least three reasons to believe that Netflix, even at these prices, could be a good long-term buy.

The domestic business pays the bills
According to Sandvine's Global Internet Phenomena Report, Netflix garnered more than 31% of U.S. downstream traffic late last year, whereas Google's (GOOGL -0.90%) YouTube site accounted for nearly 18%.

By comparison, Amazon's Instant Video managed less than 2%, and Hulu came in at just more than 1%. What is equally impressive is that Netflix added more than 3 million paid domestic subscribers in the last two quarters, and it's continually increasing the contribution margin from this business.

This performance is in stark contrast to Outerwall (OUTR), which runs the Redbox DVD and Blu-ray kiosks. In the company's recent quarter, Outerwall reported Redbox revenue growth of just 1.7%. In addition, the company's Redbox Instant streaming service seems to be an afterthought, with only a few sentences about the service in the company's last earnings release.

The first reason Netflix investors should expect more from their company is that the domestic streaming business now believes a 30% contribution margin may be possible by 2015. In the last five quarters, domestic streaming has averaged revenue growth of 5%-8% on a linked-quarter basis. With 5% linked-quarter growth and a 30% contribution margin, Netflix's domestic streaming business could grow to almost $1 billion in revenue and generate about $300 million in contribution profits by 2015.

Considering the company generated $174 million in contribution profits in the most recent quarter, this would be a significant jump. Since Netflix expects that domestic streaming profits will help pay for international expansion, a 72% increase in domestic contribution profits would be a very big deal.

International growth gives investors thrills
One of the big issues facing Netflix stock in the past was investors' lack of understanding when it came to international expansion. Netflix would report a solid quarterly profit, expand into a new country, and report a loss in the following quarter.

Now that investors have seen Netflix return to profitability after these expansions, further growth should cause less stress on the stock price. With about $700 million in cash and investments, Netflix isn't in the same league as Google, with more than $56 billion, so expansion has to be carefully managed.

This leads us to the second reason investors should expect more from Netflix: The international streaming business is growing very quickly, and losses are being cut significantly. In the last year, Netflix's international streaming business has nearly doubled from just less than 5 million paid subscribers to nearly 10 million.

More important, the company's contribution margin has improved from -100% to -26% in the last five quarters. With Netflix saying in its latest letter to shareholders, "We plan later this year to embark on a substantial European expansion," investors should expect an initial hit to earnings and cash flow. However, this should also help the international division continue its torrid growth.

New pricing plans could fill Netflix coffers
The third reason investors should expect more from Netflix is that the company has decided that one flat price doesn't work. With the company testing pricing from $6.99 a month for a single stream to $11.99 a month for four streams, Netflix should be able to increase profits from its most avid watchers.

Google's YouTube business has been toying with the idea of paid channels that would cost $1 to $5 a month. The problem is, most YouTube watchers like the site primarily because it is free. If Google pushes paid channels too hard, it could find the site's dominance decline quickly.

Outerwall's Redbox unit has an even bigger problem. The company's business is predicated on strong movie releases, and according to the company, the next few months could be difficult. In addition, in the winter months, weather can make it harder for DVD renters to get to their local Redbox.

The bottom line
Netflix is growing at a respectable rate in the U.S., and its international expansion plans are on track. While YouTube and Redbox try to change their models to make more money, Netflix just keeps on streaming along. If the company can effectively execute its plans, even today's prices could seem like a good value for long-term investors.

Chad Henage has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Google and Netflix. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Netflix Stock Quote
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NFLX
$280.96 (-0.07%) $0.21
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Alphabet (A shares)
GOOGL
$95.19 (-0.90%) $0.86
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Outerwall Inc.
OUTR

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