Netflix (NFLX +1.15%) did it again. For the third straight quarter, the streaming leader blew expectations out of the water, jumping 18% after second-quarter subscriber growth soared past projections. It's been a blowout year for the company as the stock has jumped 137%, leading the nearly flat S&P 500.
Now, for the big numbers: Netflix hit 65 million subscribers total, adding 900,000 domestic members and 2.4 million overseas during what historically has been its weakest quarter of the year. The company's international subscriber additions nearly doubled from a year ago when 1.7 million member joined the rolls.
Analysts seem to keep underestimating potential subscriber growth, believing that domestic growth has plateaued or that international growth is insignificant, but there are several reasons that investors should expect subscriber growth to keep heating up for at least the next two to three years.
The service keeps getting better
Q2 subscriber exceeded even management's own expectations. In his quarterly letter to shareholders, CEO Reed Hastings said he believed the accelerated growth was due to the streamer's growing slate of new and original shows and movies that came out during the quarter that included Marvel's Daredevil, Sense8, Dragons: Race to the Edge, Grace and Frankie, as well as Season 3 of Orange is the New Black.
In addition to the content growth, improving technology is also complementing Netflix's proliferation as more consumers purchase smart TVs and other connected mobile devices. Hastings noted that in Japan, where the company's launch is still upcoming in the current quarter, new TVs and remotes are already being sold with Netflix buttons, a sign both of the brand's power and its lasting place in the future of at-home entertainment.
The addressable market keeps expanding
Every year since its first international expansion to Canada in 2010, Netflix has been launching in new countries, expanding the territory where it's available. Last fall, it added six European countries to the list, including France and Germany, and in the spring it touched down in Australia and New Zealand. Over the rest of the year, Netflix plans to enter Japan in the third quarter, followed by Spain, Italy, and Portugal in the fourth.
Netflix's international additions were able to double last quarter in part because of the help of new markets like France and Germany.
That expanding addressable market essentially ensures that subscriber growth will keep accelerating. International subscriber additions are now outpacing domestic growth and the gap should only increase as Netflix enters new countries. The chart below shows Netflix's domestic and international subscriber growth.
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Source: Netflix.
What's interesting about that graph is that Netflix's domestic streaming subscriber growth has remained incredibly stable since the service split off from the DVD-by-mail segment in 2011. In each of the past three years, subscriber growth has been between 5.5 and 6.3 million, and the company is threatening to break that mark this year with record additions in Q1 and Q2. That level of consistency in its growth means that even in it oldest market, Netflix is far from maturing, and it's evidence that the company is well on its way to reaching its domestic subscriber goal of 60 million to 90 million households.
In its international segment, subscriber growth has accelerated every year, and this year the company is on pace to add more than 10 million new members. 2016 should bring even greater growth and as the Internet TV sensation builds on its upcoming launches in Japan, Spain, Italy, and Portugal later this year. Ultimately, the international segment will be the bigger of the two, meaning that 200 million total subscribers, or triple what it has today, should be within the company's reach, if not more. In the earnings interview, Hastings pointed out that the number of people who are interested in "video entertainment, watch some TV and have enough money to pay for a service-that's a very large potential market."
The best part for investors is that the Netflix's high growth ceiling and its business model could make it highly profitable company one day. The beauty of the subscription model is that each subscriber is marginally more valuable than the previous one as Netflix is gaining additional revenue on the same base of expenses. That means the company's domestic contribution profit -- the money it keeps after spending on content and marketing -- should continue moving toward its goal of 40%. Over the last year, that figure has jumped six percentage points to 33.1%, and early international markets such as Canada are already profitable.
Eventually, Netflix will have to deliver meaningful profits, but the company is executing perfectly, growing its subscriber base ahead of any other competitor, and strengthening its grip over Internet TV around the globe.
It's only July. Netflix's blockbuster year isn't over yet.
