Is The Upside Potential Factored Into This Content King?

Maxwell 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 been on a tear the last few days. The stock has climbed since its earnings report was released on January 23, 2013.  Sitting at just under $98 per share before the announcement the stock is now trading at almost $169 per share. Should investors sell at this point? Is there any value left in the stock?  I believe there is still some value based on where the company is at in its strategic move to become a provider of original programming. The recent growth in the stock price was based in no small part on short sellers trying to save their position as well as the solid subscriber growth Netflix produced last quarter. Below, I will explain why Netflix's potential as an original content provider is largely absent from its stock price.

Original Programming

Besides the recent announcement of a content deal with Disney (DIS) deal there is more good news for Netflix from the content side of things.  Netflix realized a few years ago that content providers were beginning to act stingier with their products.  It was decided that the future of the company would lie with original programming.  2013 looks to put that strategy to the test as many Netflix original shows come online.  Four new shows will be making  premiers in 2013 with the most anticipated being House of Cards starring Kevin Spacey and Robin Penn.  The success of these programs will go a long way towards determining whether Netflix will continue to grow or become stuck in content-provider wars with other streaming services.  I believe the company has some built in advantages to succeed in this arena. 

First, unlike network broadcasts Netflix will not have to adhere to a fall or seasonal schedule. This will allow the company to be able to hire actors they desire regardless of schedules. There will be no need to attract advertisers and keep them happy.  This has arguably been a major source of HBO’s original programming success and Netflix will be able to reap the benefits as well. 

Also, just like HBO, quality programming can come first as opposed to simply trying to garner top ratings.  Many quality shows have been cancelled by networks because of poor ratings before they could find a large audience and other shows with small, but dedicated audiences have been cancelled.  Netflix is bringing back the comedy Arrested Development which has a substantial and dedicated following but failed to attract the ratings necessary to keep it on broadcast television. 

Finally, you only have to look at HBO for proof that this model can be successful.  I believe Netflix is already far ahead of HBO as its streaming service is far ahead of HBO’s.  Production of original content will be much easier than signing up 35 million streaming subscribers.

With this strategy, how will Netflix translate its focus on original programming into increased revenue and profits?  The goal here is not necessarily to increase subscribers per original show produced and aired.  This is the network model.  Netflix showed that this is not the reason behind its focus on original programming when it released the first 8 episodes of its original series Lilyhamer all at once.  The goal is to stretch viewership out over a long period of time.  Building up original content right now can pay off several years down the road as Netflix’s service can still offer viewers access to the programming.  This will have the effect of greatly boosting margins in the future. 

But you cannot ignore the numbers in analyzing Netflix going forward.  House of Cards alone has cost the company $100 million.  At roughly $8 a month for subscriptions, Netflix will need a little over 100,000 new yearly subscribers in order to break even on the show.  While determining whether any particular subscriber signs up because of a particular show is difficult, there is a clear case for subscription growth based on good programming.  HBO saw its subscriber base increase almost 20% during the run of The Sopranos.  While it would be going overboard to predict that Netflix’s House of Cards or any other original show will be as popular as The Sopranos you can nevertheless conclude that original programming can significantly grow a company’s subscriber base. 

It is also important to note that the goal is not to make Netflix solely an original content provider, rather it’s to offer as much programming as possible to increase and keep subscribers.  As Ted Sarandos, Netflix’s chief content officer puts it Netflix “can be much broader.”  In effect it is to make Netflix resemble HBO a little more while still providing direct viewership on demand. 

Competitors

Other streaming services are also jumping on the original content train. Amazon (NASDAQ: AMZN) launched Amazon Studios and is planning on releasing up to 6 original comedy shows in 2013.  I believe Amazon is poised to be Netflix’s biggest competitor.  But a couple of things keep them in a clearly inferior position. First, Amazon’s video library is still dwarfed by the Netflix library.  Second, Amazon appears to be using its streaming service as a way to keep more customers within its total shopping environment.  Membership in its Amazon Prime provides shopping benefits, reduction in shipping costs and access to the streaming library.  The focus does not seem to be on challenging Netflix as the market leader.  

Google’s (NASDAQ: GOOG) YouTube is also increasing its original programming. The company announced 100 new original programming channels late last year.  But these appear to be in the manner of dramatic or comedic series that would compete with Netflix and more like informational channels and short one-time productions. 

Another of Netflix’s competitors, Wal-Mart’s (WMT) Vudu offers first run movies the same day they come out on DVD.  Vudu does not offer original programming and does not appear interested in doing so. 

Conclusion

Netflix will likely continue to see subscriber growth and revenue growth in the coming year.  I expect the stock to trend higher along with these numbers as well. While there is obviously far less value in the stock then there was a week ago, the stock is still a good buy. With the entire Disney catalog coming online in 2016 and the focus on original programming Netflix looks well positioned not only for this year but for years to come.  I expect the company to show modest gains through the first few months of 2013 and see it reaching $180 per share by the time it releases first quarter earnings.


StockCroc1 has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Google, and Netflix. The Motley Fool owns shares of Amazon.com, Google, 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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