Netflix (NFLX)

In this week’s blog I evaluate Netflix Inc.: current and future business strategy, financials and what would be a reasonable buy price for the stock. To quickly summarize Netflix business, customers can view TV shows and movies by video streaming over the internet and playing on TVs, computers, smart devices (cell phones, game consoles), iPads and other devices. The customer can also get DVDs delivered by mail (depending on the product level/delivery method the customer selects upon subscribing). There are no late fees, no due dates or shipping fees with any of their delivery methods (this was one of the key factors that helped drive Blockbuster, one of their major competitors, to bankruptcy). Currently Netflix have over 12 million subscribers in the US.

Netflix built its company and reputation on mailing DVDs to households and a recommendation engine that suggested videos based on consumers’ viewing history. As Netflix expands beyond North America, this delivery method will not be available to international customers, although the streaming option will still suggest shows or movies based upon your preferences.

The long range plan of Netflix is to reduce the number of DVD subscribers (DVDs shipped per day number over 2 million) and enlarge the customer base that uses video streaming. Half of their cost of goods sold or COGS ($1.4 billion in 2009) goes to the cost of postage and handling of DVD shipments. They paid the United States Postal Service over $600 million per year just to ship DVDs. It costs $1 every time Netflix sends a DVD to a customer versus less than 5 cents to stream video content.

Another long term goal is to expand internationally with video streaming only. In September 2010 Netflix launched in Canada a video streaming delivery method, charging a flat fee of $7.99 (CD) per month, for which the customer can view as many TV shows or movies as they wish. It’s similar to a franchise business, such as McDonalds, which can continue to grow revenue and profits by expanding its business into new countries. Canada has a higher broadband penetration than the US with over 70 percent of households receiving the service. There are 13 million households in Canada, so the number of potential customers for Netflix’s streaming video delivery method would be 9.1 million households. More than 10% of households in the US subscribe to Netflix’s products (DVD and video streaming). If we assume that 10% of Canadian households will have become Netflix subscribers by January 1, 2014, the revenue generated would come to around $87 million. Netflix’s current net income is 7.25 percent (this includes the high-cost DVD delivery method which will not be part of international Netflix offerings). If we assume that revenue will be 1.5 times higher for the international business, the international net income would be about 11 per cent (this is a conservative estimate – it could be higher). The Canadian business would contribute $9.5 million to Netflix’s annual net income. Another example: if Netflix decides their next expansion target will be Great Britain, and there are 3 times the broadband equipped households in Great Britain as there are in Canada, the estimated net income would be approximately $29 million per year. Netflix’s current number of outstanding shares is 52.36 million. If Canada and Great Britain contributed $38.5 million in net income, it would add $.73 to the earnings per share (EPS). This estimate is low; I would think with the low cost of streaming video the net income could be 14.5 percent which would add at least $1 to Netflix’s EPS.

There are over 500 million households globally that have broadband and that number will continue to grow over the next 10 years. Netflix is well positioned for the future to expand the brand, revenue and profit by expanding globally.

Currently the market for internet streaming video has 3 segments: video-on-demand (user pays $5 for a movie), ad supported (you see ads before viewing the content) and subscription, like Netflix. Examples of VOD competitors would be Amazon, Apple and cable companies (i.e. Comcast). Ad supported competitors include Hulu and YouTube. Netflix is the primary provider in the subscription segment. Other competitors will enter the market as consumer demand for video streaming continues to grow. Netflix will have the following advantages over its competitors in the subscription segment:

· Video streaming technology that has the ability to scale streaming video worldwide

· Revenue stream that allows it to continue adding to its movie and video content

· Excellent consumer brand recognition (like Apple and Google)

· Superior user experience

· Personalized merchandizing and technology to enhance the user experience

· Advanced technology and operational efficiency

· Expanding number of supported devices

Netflix is not an inexpensive stock. It currently sells for around $150 with a 52 week high of $174.40 and a low of $45.94. It has a current price earnings (PE) of 61 and an estimate for next year of 40. Netflix can continue to grow their brand, revenue and profit margin by expanding to international markets. Since they can deliver video streaming to your home, office or mobile device, they could also deliver other content, for example, music, magazines, e-books, etc. By expanding their product offering, they could gain market share, increase the subscription price and charge more for the added features. Netflix has one of the best consumer brands in the US. It has very high consumer ratings for customer service, delivery, ease of use, movie and TV information, personalized information, etc. With their growing scale and revenue Netflix can continue to scale video streaming and buy content for the worldwide market. I think Netflix has a lot potential and can continue to grow revenue and profits by expanding globally; after the worldwide recession subsides, they should be able to raise their subscription prices. If the stock pulls back to between $110 and $120 I will put in a buy order.

The following are some of Paul’s Gang recommended financial and investment books. If you are interested, you can select the link and get a review of the books from the Amazon website:


The Ascent of Money: A Financial History of the World
The Big Short: Inside the Doomsday Machine
Common Stocks and Uncommon Profits and Other Writings (Wiley Investment Classics)
Die Broke: A Radical Four-Part Financial Plan
The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History
The Intelligent Investor: The Classic Text on Value Investing
The Millionaire Mind
One Up On Wall Street : How To Use What You Already Know To Make Money In The Market
Security Analysis: The Classic 1934 Edition

Please chime in with comments about NetFlix. What buy price would you look for? What are your favorite financial and investment books, ideas for future blogs, etc.? Future blogs that I will be writing:

Income generating bucket of money

Investing in possible buyout companies

Understanding the Rule of 72 and why it is important for young adults

Investing in Brazil

© 2010 Paul Cusick