Netflix Still Has Immense Upside

Why investors shouldn't let the DVD and streaming giant fall off their radar.

Ishfaque Faruk
Ishfaque Faruk
Apr 30, 2014 at 6:00PM
Consumer Goods

Netflix (NASDAQ:NFLX) is on very good footing: The video-streaming giant is set to have almost 50 million subscribers at the end of the current quarter. The company's international business is on track to reach profitability later this year, and these factors will drive bigger upside in the future.

Strong fundamentals
Netflix's total streaming subscribers across the globe increased 33% year over year to 48.35 million members. Its revenues in the last quarter increased 24% year over year to $1.27 billion.

The company's operating income stood at $98 million, representing a margin of 7.7%. Netflix saw its net income increase to $53 million, showing an increase in net income for five consecutive quarters.  In order to better fund its large content expenditures, Netflix raised $400 million of debt; as a result, the cash on its balance sheet increased to $1.67 billion. 

Domestic margins are expanding
Netflix added 2.25 million domestic subscribers in the last quarter, bringing its total number of U.S. subscribers to 35.7 million. Season two of House of Cards was a big hit for the company and aided in growing the subscriber tally in the domestic market. The company's management intends to significantly increase the amount of original content spending from 10% of its total content budget. Netflix's domestic contribution margin expanded to 25.2% from the prior quarter, when the contribution margin stood at 23.4%. 

The video streaming services of Netflix and Amazon (NASDAQ:AMZN) are increasingly becoming more unique due to their respective investments in original content. Amazon has adopted Netflix's playbook and has recently increased its investment spending on original shows for Prime. 

In addition, the two companies share a great relationship. Amazon included Netflix in its Fire TV service, and Netflix uses Amazon Web Services for its cloud infrastructure. Amazon closed out its LoveFilm brand in the U.K. and Germany, and is promoting the Prime Instant Video product.

Amazon doesn't offer subscription video with Prime in Canada, France, Italy, Spain, or Japan, and will likely do so at some point in the future. In addition, Amazon struck a deal with Time Warner's HBO to add quality original shows to Prime. This is a great plus for Amazon, and future HBO shows will be added to Prime three years after their premiere on HBO. 

Netflix's management is opposed to the Time Warner Cable-Comcast merger because the combined entity's footprint would be over 60% of U.S. households; Netflix argues that the resulting company would possess anti-competitive pricing leverage over consumers when it comes to Internet connectivity, as well as over streaming companies like YouTube and Netflix. The cable companies are wary of Netflix's dominance, however. Netflix represented 58% of total video streaming in March, whereas YouTube and Amazon represented 17% and 3%, respectively, according to Qwilt.

Large addressable market overseas
The overseas opportunity for Netflix has a much larger total addressable market compared to the domestic market, and this international business is improving its contribution losses rapidly.

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Netflix added 1.75 million subs in the international segment, bringing its total non-U.S. subs to 12.7 million. The international segment saw its contribution losses decline to 35 million, and it should start churning out a contribution profit in the next two or three quarters; this should drive huge value for Netflix shareholders. The company has struck deals with cable carriers to be available on set-top boxes in Europe, and such deals with large MVPD companies will lead to healthy sub additions. 

The international segment makes up about 25% of the company's total streaming revenues. Over time, it should make up more than 50% of total revenues just like numerous other Internet companies. Netflix's management intends to invest heavily in broadening its international segment by adding more content and newer territories. 

Original shows are gaining popularity
Netflix's DVD business is still trodding along and has 6.7 million subscribers. In the last quarter, the DVD business recorded $98 million in valuable contribution profits for the company. As the company builds more original content franchises, the Netflix service will appeal to more consumers. The release of House of Cards season 3 should attract more subscribers from outside the U.S. 

Netflix is adding more and more original content to its large content selection category. The company is building high-quality franchises like Time Warner's HBO does, and will be bringing second seasons of both Orange Is the New Black and Hemlock Grove over the summer for its subscribers.

In a proprietary survey conducted by Morgan Stanley, 17% of respondents voted Netflix as the network with the best original content, behind only HBO. This means that Netflix's customers are taking note of the company's big cash investments in original content, and aiding in building the company's reputation rapidly. HBO remains the leader with 130 million global subscribers, however. 

Going forward
Netflix will enforce a $1 to $2 increase on its monthly price of $7.99 that only applies for new subscribers; existing subscribers will stay at the current price for a substantial time frame. The company can take this incremental revenue and use it to add even more content.

Netflix's increasingly large catalog of original content is building big consumer enthusiasm, leading to strong word-of-mouth marketing. The company is set to have almost 50 million subscribers at the end of the second quarter, and more sub additions in the future coupled with pricing power will drive big upside in Netflix's stock price.