Source: Netflix.
Netflix (NFLX 1.78%) stock got a big boost on Tuesday, as research firm Cantor Fitzgerald called the company "the poster child of Internet TV." It reiterated its buy recommendation on Netflix stock, and increased its price target from $450 to $500.
Of course, investors should always do their homework -- making investment decisions based solely on Wall Street recommendations and opinions is not a sound strategy. With that said, many times professional analysts offer interesting insights and points of view about a particular company. When it comes to Netflix and its leadership position in online TV, Cantor Fitzgerald seems to be right on the spot.
Size matters
The online TV revolution is on, and rising subscriber bases suggest that it will continue gaining strength over the years ahead. Considering Netflix's first-mover advantage, critical mass, and valuable library of content, the company is second to none in this promising business.
Netflix had a total of 57.4 million members as of the end of 2014, with 39.1 million of them residing in the U.S. The company gained a total of 13 million members last year, which represents an acceleration in growth versus 11.1 million new members in 2013. When it comes to demonstrating its popularity and proving its value proposition to customers, Netflix is well past the inflection point.
This critical mass is a crucial competitive advantage for Netflix, as it provides the company with the revenues to invest in content, a key factor in the industry. Using cost of revenue as a broad proxy for content costs, Netflix spent $3.75 billion in this area during 2014, a year-over-year increase of more than 20% versus $3.12 billion in 2013.
You need a big clientele and massive revenues to cover those costs, and this limits competition from smaller players in the business. Netflix brought in more than $5.5 billion in total revenues during 2014, yet the company retained only $406.2 million of that money as operating profit for the year.
In addition, Netflix collects tons of data tracking customer interactions and viewing habits, and the company leverages this information to make better purchase decisions and produce successful original material such as House of Cards and Orange is the New Black. More subscribers mean more money, and more information from those subscribers enables Netflix to invest revenues in a smart way.
Moving forward
A bigger Netflix means a stronger Netflix. Management understands how these dynamics work, and the company has recently announced that it will be accelerating its international expansion plan during the next couple of years. Netflix said during the last-quarter conference call that it will be expanding its reach from a current base of 50 countries to nearly 200 by 2017.
According to management, the proliferation of smart TVs, smartphones, and tablets will make this growth possible. Not to mention that Netflix also has learned a lot about the kind of content that viewers in different countries prefer, and how they respond to different marketing initiatives.
Competition is on the rise, and it makes sense to assume that different players will keep increasing their pressure in the years ahead. However, there's no reason to believe that the online TV market will be a zero-sum game in which one company's gains are the other one's losses, and the winner takes all.
Time Warner (TWX) is arguably the biggest threat when it comes to content quality. But it's worth noting that HBO's recently launched HBO Now service costs $14.99 monthly, a considerable premium versus Netflix and its monthly fee of $8.99. HBO's venture into the business could even validate Netflix's customer proposition and provide some room for the company to raise prices in the future.
Amazon (AMZN 0.09%) is much more competitive when it comes to prices. Amazon Prime costs $99 per year, and it offers other benefits such as free two-day shipping and access to Prime Music and Kindle Owner's Lending Library, in addition to Prime Instant Video. However, even if Prime has been growing rapidly in the U.S., this has not been a problem for Netflix so far.
According to data from a report by Nielsen, 36% of American homes subscribe to Netflix, versus a penetration rate of 13% for Amazon Prime, and a much smaller market share of 6.5% for Hulu Plus. It's important to note that prices in online TV are much lower than in traditional pay-TV, so consumers can easily afford to subscribe to multiple streaming services, as long as the content is worth the cost.
While no company is completely immune to the competition, Netflix seems to be firmly on its way to consolidating its position as the main beneficiary from the online TV boom during the years ahead.
