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For Netflix, Inc. (NASDAQ:NFLX), Sharp Reaction From Investors to 3Q2014 Results

Written by on October 17, 2014

Netflix, Inc. (NASDAQ:NFLX) seems to have reached the exalted status that few companies reach where a company’s performance leads to often outsize reactions from investors. This is justified when a company is a recent startup. However, Netflix is no new-kid-on-the-block. Perhaps today’s sharp reaction from investors to the 3Q2014 results is a reflection of the high expectations they have from the company. Certainly, with a P/E ratio of 96.2 at market close on October 16, Netflix’s stock price enjoys a much higher multiple than bellwether stocks like Apple or Google. Only Amazon enjoys a better P/E ratio.

The Not-So-Bad 3Q2014 Results

The thing that spooked the investors the most was the slow growth of new domestic subscribers at only 0.98 million compared to the prior projection of 1.33 million. This was also below 3Q2013 net domestic subscriber additions which were 1.29 million. Netflix now projects new subscribers of 1.85 million in 4Q2014 compared to last year’s actual additions of 2.33 million in 4Q2013.

Internationally, Netflix added 2.04 million streaming customers in 3Q2014 compared to the net addition of 1.44 million subscribers in 3Q2013. This comes below the projections of 2.36 million net subscriber additions Netflix had made in the last quarterly report filing.

Netflix ascribes this slowdown in new subscribers, especially domestically, to the recent $1 increase in monthly subscription fee from $7.99 to $8.99.

Talking about the $1 increase in monthly subscription fee which led to this lower-than-expected growth in new subscribers, Netflix is not really in a big hole because of slower subscriber growth. Let us crunch a few numbers.

If roughly 2 million new subscribers pay the $8.99 monthly subscription fee, then Netflix earns $216 million per year from them. If 2.5 million new subscribers were to join if the subscription fee were kept at the old rate of $7.99, then Netflix would have earned $240 million. The difference between the two amounts is not that large. When the existing 30 million plus subscribers go on to the higher pay slab, Netflix earns an additional $360 million per annum from them without needing to make any new investments in marketing, technology, hardware, or content, or having to navigate any messy legal complications in a new country.

However, the overall numbers were far from gloomy.

3Q2014 revenue came in at $1.22 billion compared to $884 million in 3Q2013, $962 million in 4Q2013, $1.06 billion in 1Q2014 and $1.15 billion in 2Q2014. Clearly, Netflix continues to grow its revenue consistently and has projected 4Q2014 revenue of $1.3 billion.

The 3Q2014 revenue also matches the projections of the company made during the last quarterly report filing.

At this point, Netflix boasts of a massive 53.06 million subscribers and paid members have crossed 50 million for the first time to reach 50.65 million. Netflix projects total members to grow by 4 million in the next quarter and paid members to grow by about 3.5 million.

With domestic paid streaming members number at 36.27 million and international paid streaming members at 14.39 million, the way to grow seems internationally. Netflix is expanding into six new European territories as of this moment including major markets like France and Germany.

In terms of net additions, while it added 2.04 million streaming subscribers internationally, it only added 0.98 million streaming subscribers domestically. This shows the way Netflix must go.

Net income continues to remain slim for Netflix so far. With happy spending in marketing and technology and development, Netflix reported 3Q2014 net income of $59.29 million and diluted earnings per share of $0.96.

Hey Netflix, You’ve Got Competition

Not that the increasing competition will take Netflix aback since Netflix has always insisted that HBO is there main competitor in the long run. So, HBO’s announcement to start offering online subscription-based content only proves Netflix’s prophecy right.

HBO’s rich bouquet of hit shows including Game of Thrones as well as its access to its parent company Time Warner’s movies makes HBO a strong competitor to Netflix. However, Netflix is the more experienced player in the online streaming game and has learned to deftly navigate the minefields of country-specific content ownership rights not to mention the different legal environments in different rights.

HBO cannot just make everything available to everyone globally and will take many years to replicate the path Netflix has taken.

Meanwhile, ecommerce behemoth Amazon continues to splurge billions on new video content — according to Sanford C. Bernstein estimates, Amazon is likely to spend $2 billion this year and $2.5 billion in the next year on video content. Amazon of course offers free video subscriptions to its Amazon Prime subscribers.

Netflix Got Content

After hit original shows  such as House of Cards and Orange is the New Black, Netflix also recently announced a push into original movies, making deals to finance four Adam Sandler films and a sequel to the Oscar-winning martial-arts drama Crouching Tiger, Hidden DragonCrouching Tiger will debut simultaneously on select global IMAX screens and in Ultra HD 4K on Netflix. This new movie distribution model has left movie studio owners and those in the movie distribution business none too happy. Netflix believes Adam Sandler’s comedy are one of those rare content that never grows old and attracts audiences year after year.

Still talking original content, the company has also expanded into the adult animated comedy genre with BoJack Horseman after licensing hit series like Archer, Futurama, etc.

Hemlock Grove and The Killing also arrived this quarter. The company launched original documentaries in the 3Q2013.

Netflix announced on Wednesday that it will stream the entire Friends sitcom in 2015.

Love UHD? Pay More

Netflix is not even done raising prices with the $1 raise last May. For those with the latest 4K UHD technology TVs who get content streamed at a massive 3840 X 2160 resolution, Netflix got news. They will be asked to pay $11.99 per month now — up 4$ from the earlier $7.99.

So, in a year or two from now, Netflix subscribers will be in two price tiers — some paying $8.99 per month and others paying a premium rate of $11.99 per month to enjoy shows like House of Cards and Breaking Bad and movies in sparkling UHD clarity.

Netflix justifies the fee increase as related to the deals it has struck with the ISPs like Comcast and Verizon who carry Netflix’s shows and movies. Netflix will pay them a certain amount to let Netflix users get priority access to these ISPs’ bandwidth. Some of that expense is being passed on to the customers.

This fee hike, like the other $1 fee hike is applicable to new subscribers and existing subscribers — those who were already Netflix customers before August 12 — will be paying the same old rate till August 12, 2016.

Netflix at $500, Anyone?

With the markets going berserk on Thursday when Netflix shares fell nearly 20% to close the day at $361.7 from the previous day’s close of $448.59, there probably are not many brave hearts who are betting on Netflix breaching the $500 level soon.

But the Netflix story has not fundamentally changed between Wednesday and now. Considering it reached a historic high of $489 only about a month ago, it can go up again. In fact, the current levels may be the cheapest rate at which you can buy Netflix before it starts its upswing.