Editor's Choice

Netflix Is a Long Term Buy

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

Netflix (NASDAQ: NFLX) has disrupted the way users consume TV shows and movies via a low cost subscription online. Its large content library and low price point is a major value proposition of the company. The brand value of Netflix is unquestionable, and is becoming a key differentiating point as the company goes global. Netflix has immense upside in the long-run, and ten key factors will drive the company's value going forward.

Ten Key Drivers for Netflix in the Long Run:

1. Long-Term Focus: Management is completely focused on building out a global Internet TV platform in the long-term. The company's priorities are firmly rooted in building out a global brand name, acquiring new customers and keeping existing ones very satisfied. 

2. Secular Shifts: Due to the secular industry growth trends, higher levels of internet penetration across the world will aid substantially in growing subscribers especially in growing regions of the world. Also, as more and more Smart TVs and tablets are sold with built-in Netflix buttons, this will provide additional tailwind for growth.   

3. Category Leader: Netflix is a first mover in building out a disruptive Internet TV Platform, which was a brilliant strategic shift from its original DVD by mail business. The company is now light years ahead of competitors like Amazon (NASDAQ: AMZN), Hulu and Coinstar powered Redbox in terms of subscribers. Clearly, Netflix has reaped the rewards from the first mover advantage.  

4. Compelling Unique Value Proposition: Netflix's unique value proposition is pretty clear and simple, a very low price point along with a large content library. This value proposition has worked very well with users. The unlimited streaming price of $7.99 a month is cheaper than a movie ticket to a theatre and substantially lower than a cable connection. And it also gives members the flexibility of watching shows according to their own schedule, unlike regular TV where users play by the rules of the TV Channel. 

5. Content Library: Netflix has a very large content library with an estimated 60000+ titles for streaming. The Recurring revenue model allows Netflix to consistently add more content, which in turn attracts more subscribers. The company's deal with Disney (NYSE: DIS) for first run content doesn't go into effect before 2016, but in the meanwhile, Netflix will be adding many movies from Disney's catalog, which will aid in growing subscribers.

6. Growth in New Users: Netflix is rapidly getting more and more users for its 1 month free trial offer. At the end of Q4 F'12, Netflix had almost 3 million free users, which is up by roughly 1 million from a year ago. As its global footprint increases, with newer launches in many European and Latin Countries, this number can be expected to grow faster.

7. Competitive Threats are Exaggerated: The threat of competing firms are a lot less than initially feared. Two of the biggest rivals, Amazon and Hulu are both creating original content, which makes their service markedly different from Netflix. And also, Netflix's management portrayed that the amount of overlapping content between Redbox Instant, Hulu and Amazon is not substantial.

Amazon has deep pockets and is funding a number of original content which will allow viewers to choose or cut off a series by viewing the pilot. Whereas, Disney backed Hulu, is owned by three of the largest content firms in the world, and can add a lot more content going forward from the parent companies comprised of News Corp, Comcast and Disney itself. 

However, Verizon (NYSE: VZ) is a major player in the pay-per-view market and has a large content library for its existing cable customers. The Verizon and Coinstar powered Redbox Instant can pose strong competition down the road, but for now, it hasn't gotten off the ground. The combination of Verizon's existing content library and the thousands of DVD kiosks of Coinstar might be a force to reckon with down the road. 

8. Original Content: Netflix is increasingly building out original content with its partners. Original content that is exclusively available only to Netflix members is a strong service differentiation strategy. The company will be releasing a number of original shows in 2013, and some shows feature big name stars like Kevin Spacey. In addition to attracting new users, the original content increases the brand value of Netflix across the globe. 

9. International Footprint: Netflix is rapidly adding subscribers in Europe and Latin America and now boasts of more than 6 million subscribers. The company remains heavily focused on building out the International platform by adding content, and as a result, is losing money in its operations. But as more subscribers come in, margins will improve significantly down the road. 

The addressable market for the Netflix is huge, with more than 50m potential subscribers in the Latin America region alone. And Netflix has also taken steps to improve payment collections from customers in Latin America as well, which was a headache for the company previously.  

10. Margins will Improve: Netflix trades at a very rich multiple of the trailing twelve month earnings, but the P/E multiple doesn't incorporate the company's future upside. Netflix's earnings have taken a major hit due to the build-out of its international operations and will take a U-turn once more subscribers start tuning in.

Over the next few quarters, the international operations are expected to have better contribution margins. And thus, the company’s consolidated margins and free cash flow will improve heavily. As a result, the company's value should be assessed based on its long term growth trajectory, and not on its current P/E or even the forward P/E. 

The Takeaway

Netflix is increasingly widening its competitive advantage with a mix of exclusive and original content. The company is absorbing losses from its International platform, for the sake of building out a long-term profitable franchise across the globe. As the company's international operations come of age, its operating and net margins along with free cash flow will increase exponentially from current levels. As a result, the company has immense upside in the long-run.

ishfaque has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Netflix, and Walt Disney. The Motley Fool owns shares of Amazon.com, Netflix, and Walt Disney. 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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