On a day the NASDAQ was down about 0.2 percent, Netflix hit a new all-time high during intra-day trading, hitting $122.78 and eventually closing at $121.00 per share, up 7.5 percent on the day.
The video streaming service has seen its shares rise 143 percent so far in 2015. A stock split, Icahn cashing out, and and encouraging earnings reports have spurred investor’s attention in the company, as has its recently announced entry into Asian markets.
Speaking of Icahn, the activist investor has missed out on hundreds of million of dollars in profit by selling early. The day he announced that he had liquidated the remainder of his Netflix holding, the stock was trading at about $96 dollars, adjusted for the recent 7-1 split. Today the stock closed at $121, representing a missed return of an additional 26 percent.
While few doubt that Netflix has a strong future ahead of it, it’s worth taking our time to examine the company’s strengths, recent past performance, and expected financial takings. Are investors over their skis, paying too much for future growth today? Or, perhaps, is Netflix’s coming few years strong enough to cover for its dramatically accelerating valuation?
Why New High?
The day started with news that Netflix has finally confirmed a launch date for it’s long-awaited expansion into Asia. The company launched a Netflix Japan Twitter account, as well as confirmed a September 2nd launch date, according to VentureBeat.
While the company announced they would be launching in Japan almost 6 months ago, it was a hot topic in the company’s Q2 earnings call a few weeks ago.
Reed Hastings, CEO of Netflix, said that the company will launch with localized content and an aggressive pricing strategy, in part to avoid the failure that Hulu encountered during its initial Japan launch. Hastings also noted that the company has support from all the major Japanese consumer electronics brands, and Sony, Panasonic, and Toshiba will all be integrating Netflix buttons into their TVs sold in Japan.
The news of an official Japan launch date may also be reinvigorating investor’s excitement about upcoming launches in southern Europe, Spain, and Italy, all of which will come in Q4.
Additionally, a portion of today’s rally may be attributed to the fact that investment firm Guggenheim Securities just initiated coverage on Netflix, and rated it a “buy” with a $160 price target. This $160 target is a 33 percent increase over what the stock closed at today.
Netflix’s Moat Against Subscriber Churn
Part of Netflix’s long-term rally may be attributed to the low churn rate of subscribers, as well as the fact the most users find Netflix’s current price of $8.99/month for new customers to be very inelastic.
A May 2015 survey by RBC Capital Markets of 500 respondents showed that 73 percent of users were “not at all likely” to cancel their subscriptions in the next three months, and only 6 percent were either “extremely likely” or “very likely” to do so.
In terms of inelasticity, the same survey showed that only nine percent of users were “extremely likely” or “very likely” to cancel their subscription once the $1 price increase goes into effect. This number is down three percent from a year prior, and will most likely continue to decrease as strong, original content will keep subscribers attached to the platform.
On a less technical note, as long as Netflix’s subscription price continues to be dramatically below the price of a cable subscription ($64/month, according to the FCC), its reasonable to assume that as long as the company continues to provide quality programming, there is a lot of room for future pricing increases.
Financials, And Other Tidbits
A few statistics: Netflix’s revenue in the first half of 2015 grew to $3.2 billion from $2.6 billion in the year-ago half year. That’s an increase of 23 percent. In the same comparative half year period, Netflix saw its operating income fall from $227.2 million, to $172.3 million. That’s down around 24 percent.
On a strict-profit basis, Netflix’s net income fell from $124.1 million during the first-half of 2014, to a far-slimmer $50.0 million in its most recent six months, down around 60 percent. Summing, Netflix has paid for seemingly tepid revenue growth with steep declines in its profits. If you were to only look at Netflix’s traditional corporate metrics, however, you might miss part of the picture.
(The joke about Netflix’s forward price-earnings ratio topping the 400 mark you can make yourself.)
However, raw financial performance is only part of the growth picture that investors appear to use to value Netflix — that’s to say, the pace by which Netflix accretes new subscribers on a net basis is perhaps a more important way to measure the firm’s future potential incomes.
Before you yell GAAP and let slip the SaaS dogs of war, wait. Given our previous discussion of price inelasticity on the consumer side, which implies potential positive dollar churn on a per-account basis, Netflix’s low account churn becomes a long-term profit engine. So, in terms of growth, cutting profits now to build a larger subscriber base may not only be a fair trade, but one that could be intensely lucrative in the long term.
SaaS And Subscribers
If that last comment seems to echo back to Box, and its massive losses in the face of growing a recurring revenue base, you might be slightly confused as to how Netflix is investing in content, and expansion, while still making money.
A small hint: Netflix’s DVD business brought the firm a self-declared “contribution profit” of $77.9 million in the second quarter. That’s more, you’ll note, than the firm’s first-half-year net income by a wide margin. So, in an interesting way, Netflix has a free source of profits that allow it to grow its recurring digital incomes, effectively subsidizing the costs thereof.
That makes future cash flows from current subscriber growth less expensive than they might seem. And, how is that same subscriber growth doing, both at home and abroad, in its last quarter? Here’s the company:
We added a Q2 record 3.3 million new streaming members, compared to 1.7 million in the previous year quarter. […] We gained 0.9 million members in the US and added 2.4 million members internationally in Q2. […] We are forecasting Q3 US net adds of 1.15 million, slightly higher than the year ago period. […] We project Q3 international net adds of 2.4 million.
To collate that, not only is Netflix growing its subscriber base at a faster pace than it did in the year-ago quarter, but Netflix expects its current quarter to be even stronger.
And if you are betting that you can charge those same subscribers more over time, and they just won’t leave, then your CAC is House of Cards and your LTV is fucking gold.
Disclosure: One of the authors owns a small amount of shares in Netflix by way of a family trust.