Netflix (NFLX +0.34%) in 2014 posted surprisingly high profits, added millions of streaming subscribers at home and abroad, and dramatically expanded its total addressable market. Yet the stock underperformed on the year, falling 9% to date as the S&P 500 rose by 11%.
Wall Street doesn't seem as confident as it once was that the streaming video giant can coast to world domination over the next few years. Instead, Netflix's third-quarter earnings report introduced new uncertainties around the business and its overall growth potential. Here are two key questions that Netflix investors should get answers to in 2015.
What part of the S curve are we on?
Growth might sound like a strange worry for Netflix investors. After all, the company added 5 million new members to its U.S. subscriber rolls in the last four quarters. Two years ago that base sat at 25 million -- now it's pushing 40 million.
Image source: Netflix.
But the pace of expansion might be tapering. In fact, it dipped below prior-year growth for the first time in the third quarter. Worse yet, Netflix projects more of the same in the fourth quarter: member additions should be 1.9 million, well below last year's 2.3 million. Here's how management described the growth dynamic in 2013 at a time when it was trending at comfortably above the prior year's gains:
Running equal to, or slightly above, prior year net additions is a great outcome because it implies that at 33 million domestic members we're still in the middle section of the S curve of consumer adoption, with years of member growth ahead of us.
We'll find out in the next few quarters if Netflix is closer to the middle of the S curve, with all those years of steady member growth ahead, or the top, which would point to slowing growth in the U.S. and less profit gains to pump into international expansion.
When will profits start flowing from international markets?
Meanwhile, Netflix is in a furious international land grab right now, trying to establish itself as a leader in as many broadband-addicted societies as possible before rivals can. That push has resulted in lots of membership growth: From a standing start two years ago, the international business now counts 18 million subscribers.
But traveling abroad is expensive, and there's no guarantee if or when each new market will stop sucking profit and start contributing to earnings growth. At the beginning, huge content and marketing costs must be allocated over a tiny user base, all with the hope of growing to profitable scale within a few years.
Canada, Netflix's first expansion, represents a best-case scenario in which profit margin is now about the same as in the U.S., a strong 28%. Latin America, meanwhile, hasn't been nearly the same success, and Netflix is still struggling to get that region's profitability up.
Netflix just launched in six European markets that together boast over 60 million broadband households. Australia and New Zealand are on tap for early 2015. However, the company projects a $100 million loss for its international business in the fourth quarter, which would be the biggest hit in two years.
That scale of investment won't matter at all if international markets ultimately perform as management hopes. But there is a wide range of possible outcomes in these markets. And 2015's results should tell us whether the international profit profile as a whole will look more like Canada or Latin America.
