Stock Research: Netflix (NASDAQ: NFLX)
Netflix (the “Company”), which started in 1997 as a DVD-rental-by-mail firm, spent many years struggling to determine their business model. Once positioned, the company then went head-to-head with Blockbuster and eventually bested the goliath through their streaming services, launched in 2007. The Company then launched streaming services internationally in 2010, and has been on an upward path of subscriber growth ever since. Due to strong recent performance, the Company has even surpassed 100m subscribers.
Netflix shares was among the S&P 500's biggest gainers in 2013 and 2015, and many believe their growth will continue. The Company is placing a large bet that internet TV will eventually replace linear TV, and up to this point, it appears they are steadily on that path.
Current & Future Industry Status
Netflix continues to surpass investor expectations. The Company’s vision is that internet TV will replace linear TV and if this were to occur, the following factors would play a large roll:
(1) Internet Speed and Accuracy: The internet continues to increase its speed and is becoming more reliable in various parts of the world. Penetration of smart TVs and smart phones domestically and internationally is also growing.
(2) Consumer Demand for Flexibility: The Company’s growth has been attributable to consumer demand, wanting to watch shows when and where ever. The growing existence of customized programs is gaining more momentum.
(3) TV Innovation: Technology continues to pivot while internet TV apps have continued to innovate as well. The ability and quality for streaming services is tantamount to Netflix’s success.
Recent Performance: Q2 2017 Results
Netflix released their Q2 2017 earnings report on July 17th and blew away forecasts by adding 5.2m new subscribers, far surpassing analysts estimates of 3.2m. This surge of subscribers was driven by international growth, increasing +4.14m overseas, while domestic subscribers increased +1.07m (down -25% QoQ). Despite huge increases in subscribers, Netflix reported earnings of 15 cents per share, missing estimates by 1 cent. Additionally, the Company reported quarterly revenue of $2.79b (+32% YoY) but missed earnings estimates by $2.9m, coming in at $65.6m. The stock market responded well to the news, sending the Company's shares up +10% shortly after the news release, indicating that the market is watching subscriber growth more so than earnings.
Netflix Success Factors
Netflix’s stock price has increased drastically since its initial IPO (up over +2,400% as of August 2017) and there are little signs of the Company slowing down. Continued success and expansion will be determined by their ability to increase international expansion, grow their subscriber base, strategically plan content spending, and differentiate themselves from intense competition.
In their most recent release to investors, Netflix outlined their global margin strategy as expanding as fast as possible while remaining profitable. The Company’s international segment now accounts for 50.1% of their total membership base, and international revenue rose +57% YoY (Q2 2017). As of Q2 2017, the Company has 52m international subscribers and for the first time international subscribers has exceeded domestic subscribers. Despite this, Netflix is still in the early stages of international expansion: some analysts believe the Company could hit hundreds of millions of subscribers in just a few years. One analyst from Piper Jaffray estimates that Netflix's international paid subscribers base will grow to 79.6m by 2020, indicating 16% penetration of households with internet access (excluding China).
Due to the continued growth of internet TV, Netflix believes they can reach somewhere between 60m and 90m penetration of subscribers in the US. This goal seems possible given the Company’s track record: they have exceeded +20% YoY subscriber growth in each of the past eight quarters (+24% on average). Driving subscriber growth could be the ever-elusive millennial consumer. Specifically, there are approximately 70m millennials that watch Netflix but do not pay (i.e. they use someone’s login); if the Company is able to convert this audience, even at a 3% annual conversion rate, they could add +5.3m subscribers by 2020.
In April 2017, Netflix took on an additional $1.1b in debt to fund its spending on content, pushing its long-term debt to $4.8b. In 2017, the Company expects to spend over $6B on content members, while also expecting to spend over $1b on technology & development. The Company is making large plays in their long-term success with the hopes that this spending will continue to grow their audience.
Large-cap tech companies, specifically Amazon, are investing heavily in original and licensed content around the world. In contrast with many years ago, creating a TV network is now as easy as creating an app, causing large amounts of investment in content production worldwide. As a result, Netflix faces intense competition: as of Q2, Amazon had 85.3m viewers (44% of users), Hulu had 32m viewers (16.5% of users), and HBO Now had over 2m subscribers domestically. In addition, YouTube is capturing over a billion hours a day of consumers’ time as compared to Netflix capturing over a billion hours a week with their entertainment.
In the future, the Company can expect even fiercer competition, since Amazon Prime Video expanded into more than 200 countries late last year and plans to spend $5b on content in 2017 alone.
Future Outlook & Summary
One risk investors face with Netflix is that there is nothing to fall back on when subscriber growth slows or declines. Netflix stock invariably performs poorly whenever subscriber growth misses targets, as seen in 2014 and 2016. Despite this, the Company’s continued investment in content continues to build a stronger competitive advantage vs. their competitors. And while this strategy is likely to pay off in the long-term, the Company will face short-term trials and even expects to have negative free cash flow “for many years.” With rivals like Amazon and Hulu continually creating more content— and with large tech companies like Apple jumping on board—Netflix clearly needs to differentiate themselves to continue adding subscribers.
Netflix has the vision and execution ability to remain the #1 streaming TV provider assuming they continue on their current path. Analysts at Piper Jaffray claim: “Netflix profits for 2020 could double the current expectations if the international growth path follows its domestic business” and as a result, could increase to a price of $190 per share, up from $161.70 as of July 17th and $181.33 as of August 7th, 2017. As such, investors and analysts alike will be watching subscriber increases as well as international penetration closely to determine the potential for Netflix to continue their expansive growth patterns.