Why Netflix Is Still on the Rise

Ben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In the age of technology, we have grown accustomed to having what we want when we want it. This is especially true for television, and with Netflix (NASDAQ: NFLX) our demands are met. Netflix provides internet television service to computers, televisions, and mobile devices domestically and internationally. With online streaming and by-mail DVD deliveries, it is one of the most convenient ways to enjoy television and movies. But Netflix has more going for it than convenience. 

New shows

Netflix is working on content as its competitive advantage. The company has exclusive contracts for content from Turner Broadcasting and Warner Brothers, allowing it to stream shows from TNT, Warner Bros. Animation, Cartoon Network, and Adult Swim.

Netflix has also invested in new, original programing such as the popular House of Cards, Arrested Development, and Hemlock Grove. These new shows are released by season, rather than by episode, allowing the customer to decide when they will watch the show. This strategy created positive media buzz that helped promote Netflix’s new shows.

There was also worry that customers would use one of Netflix's free monthlong trials to watch the shows, then cancel their subscription. Of the millions of Netflix trial users, only 8,000 canceled their subscription during the most recent quarter when the shows premiered.  This proved that releasing compete seasons of original content is the right move for Netflix.

Most recently, Netflix struck a deal with DreamWorks Animation (NASDAQ: DWA) to provide 300 hours of original programming for children. This is an extension from the deal the two companies made to produce the original show Turbo F.A.S.T. This content deal will allow DreamWorks to utilize characters received in its $155 million acquisition of Classic Media, including He-Man, Casper, Waldo, and Rocky and Bullwinkle. The new deal will also allow DreamWorks to rely less on box office success while getting a larger return from the characters in past films.

For Netflix, the DreamWorks deal has given the company independence from nonexclusive, bulk contracts. The company is letting its contract with Viacom expire, losing shows such as Dora the Explorer and SpongeBob Square Pants.

\DreamWorks CEO Jeffrey Katzenberg is excited about the agreement, stating, “This is an unprecedented commitment to original content in the internet television space. Netflix is a visionary company that continues to redefine the way audiences watch television.”

While important, original programming is very expensive. Netflix has $5.7 billion in long-term content contracts and is spending $100 million on House of Cards alone. Content costs are also largely responsible for the company’s negative free cash flow of $42 million.

Recent Performance

Last quarter, Netflix posted net income of $3 million, which yields an earnings per share of only $0.05. During this first quarter, the company added more than 3 million streaming members, each paying $7.99 a month for access to the company’s library of 75,000 titles. These new members bring the total number of members to 36 million, who have watched a combined 4 billion hours of television on Netflix.
Domestic new membership is responsible for 2.03 million of these users. Domestic streaming contribution margin increased by 20.6% as a result of this membership growth outpacing content spending.

Netflix's international membership totals 7.1 million, after a 1 million-member increase during the most recent quarter.  This resulted in an international revenue of $142 million, which is substantially more than the $42 million international revenue the company had during the same quarter last year. The international market is not yet profitable and recently had a contribution loss of $77 million.  This is $28 million improvement, and Netflix plans to continue to international expansion. 

Amazon competition

Netflix’s biggest competitor is Amazon.com (NASDAQ: AMZN). For a yearly subscription of $79.99, customers have access to Amazon’s streaming library of 38,000 TV shows and movies, a Kindle library, and free two-day shipping for Amazon products. While it is cheaper than Netflix, its streaming library is only slightly over half Netflix's size. Of Netflix’s top 200 titles, Amazon only has 74, further separating the two competitors' libraries.

Amazon is in the process of releasing original content to compete with Netflix. Launched in 2010, Amazon Studios is currently developing 24 movies that are being tested with audiences. The company also has 5 original TV shows premiering later this year and early next year. These shows include Alpha House, Betas, Annebots, Creative Galexy, and Tumbleaf. With these new shows, Amazon hopes to replicate the success of House of Cards.

Netflix has a dominant market share of compared to Amazon. The company has 89% of all television streams compared to Amazon’s 2%. Amazon and Netflix have P/E ratios of 89.27 and 73.24 respectively which shows investor’s confidence in the two companies’ growth. Netflix has a higher gross margin of 27% compared to Amazon’s 25%. Netflix is currently winning the streaming competition, but this battle is only just beginning.

Conclusion

Internet television is the future of entertainment and Netflix is leading this high growth industry through content and customer convenience.  Exclusive and original content will allow the company to continue to increase membership and drive earnings growth.  The company is still laying the foundation for its international business but it will be a large source of profit for Netflix in the future. With Netflix's potential, I only see earnings going up from here. I think Netflix's stock and service are both a buy.     


Ben Popkin has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, DreamWorks Animation, and Netflix. The Motley Fool owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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