Should You Expect Victory Or Calamity From Netflix, Inc. (NASDAQ:NFLX)?

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Netflix, Inc. (NASDAQ:NFLX) surpassed its own subscriber growth target in 1Q2016 as EPS and revenue readers for the quarter also largely impressed. The company is betting on international expansion and original content to fuel long-term growth. But as Netflix expands abroad and funnels more funds to creating original shows, its expenses are also ballooning.

Will high spending on originals, loss-making international operation and rising interest expenses choke life out of Netflix? This Netflix analysis article examines the company’s risks and opportunities as it pursues more growth abroad and deepens penetration domestically. But first, here is a quick recap of 1Q2016 earnings results.

1Q2016 highlight

Netflix, Inc. (NASDAQ:NFLX)’s revenue for 1Q2016 ballooned to $1.96 billion from $1.82 billion in the previous quarter and $1.57 billion a year ago. EPS reading of $0.06 increased from $0.05 a year ago. Analysts were looking for EPS of $0.03 on revenue of $1.97 billion.

What’s exciting about Netflix?

  1. Strong subscriber growth

Netflix, Inc. (NASDAQ:NFLX) added 6.74 million new subscribers in 1Q2016, to push its consolidated subscriber base to 81.5 million. The company enrolled more subscribers during the quarter than the target of 6.1 million that it had set for itself. Domestically, Netflix gained 2.23 million subscribers, while it added 4.51 million subscribers internationally.

Netflix is betting on subscriber growth to drive long-term revenue growth. As such, the company is aggressively expanding abroad. To win against international rivals, Netflix is creating original and exclusive content that can only be watched on its platform. Domestically, Netflix is not done pursuing growth despite the growing challenge of winning over new subscribers. Price hikes are some of the strategies Netflix plans to use to grow its domestic revenues.

The chart below shows Netflix’s paid subscribers domestically and internationally for the last five quarters:

NFLX

     2.Focus on original content

Netflix has identified original programming as a key competitive advantage. Originals serve as a bait to draw subscribers to Netflix and have them locked in on the platform. The company plans to funnel $6 billion to create original shows this year. It spent $5 billion for the same project in 2015. The other reason Netflix is doubling down in original content production is that owning content rights means the company is steadily kicking content licensing costs and the restrictions that come with renting movies from third-parties. Therefore, over the long-term, those savings would boost earnings and the company would gain greater control of its business.

     3.International expansion and paid subscribers

As Netflix, Inc. (NASDAQ:NFLX) expands abroad, it is also getting many subscribers to pay for its service. To fuel paid subscription, the company has come up with a one-month trial that gives prospective customers a taste of what they can expect from the company. In 1Q2016, Netflix had 45.71 million paid subscribers in the U.S., up from 40.32 million in the like quarter a year ago. Paid international subscribers were 31.99 million, an increase from 19.30 million a year ago.

Netflix activated its service in 130 countries simultaneously in January. With the move, Netflix is now available in 190 countries, closer to the target of 200 countries by the end of 2016.

     4.Mobile access

Netflix is stealing viewers from legacy broadcasters with the promise that they can watch television anywhere, anytime on its platform. To make good that promise, the company has come up with apps that enable subscribers to stream videos on their handsets. Netflix apps are available for Android and iOS devices. Creating apps for these popular mobile platforms not only ensures that Netflix delivers its videos anywhere, but is also helping the company to grow its subscriber base.

     5.Enhanced quality

In addition to expanding its library of original content, launching in more international markets and opening wider mobile access, Netflix, Inc. (NASDAQ:NFLX) is also in the process of bumping up the quality of its service. The company has come up with a content delivery network (CDN) that it calls Open Connect.

Through Open Connect, Netflix is able to increase the speed of video delivery, thus ensuring seamless, high quality streaming. Open Connects also ensures that streaming video consumes less of the user’s bandwidth, so people can stream more without significantly increasing their Internet bills.

What’s worrying about Netflix?

  1. Stiff competition

Competition is tough in the on-demand video market. Netflix, Inc. (NASDAQ:NFLX) is vying for subscribers against Amazon.com, Inc. (NASDAQ:AMZN)’s Prime Video, Dish Network Corp (NASDAQ:DISH)’s Sling TV, Alphabet Inc (NASDAQ:GOOG)’s YouTube Red and a host of other providers.

When competition becomes intense, companies tend to spend more on marketing campaigns, thus squeezing margins. Additionally, stiff competition may trigger pricing wars that could hurt Netflix’s revenue growth and profitability.

     2.The Amazon issue

Besides the overall competition in the Internet-based video business, Netflix could be in for a rougher run in 2Q2016 and beyond than it anticipated. Just as the company guided softly for subscriber growth in the current quarter, Amazon has launched a more competitive video streaming service. Amazon has come up with a $9 a month streaming service that is independent of the $100 a year Prime loyalty subscription.

That means that those who could not subscribe to Amazon’s Prime-tied video streaming plan because of high upfront cost now have a more palatable option. But Amazon’s new $9 a month video plan will pile more pressure on Netflix whose standard service costs $10 a month.

     3.Ballooning expenses

Netflix, Inc. (NASDAQ:NFLX) is pumping increasingly more funds to its international expansion and original programming initiatives. The company borrows to fund its various projects, but taking on more debt means the company is adding more burdens in the form of interest expenses. Netflix had long-term debt of $2.37 billion at the end of the March quarter.

    4.Currency headwind

Netflix’s international expansion will also come with risk – exposure to global currency volatility. As international becomes a significant contributor to Netflix’s topline, the company will have to contend with unfavorable forex movements that can wipe a significant portion of international revenues if the dollar firms against foreign counterparts.

It is also worth taking note that Netflix’s international business is still a money-losing operation.

      5.Soft subscriber growth guidance

Although Netflix, Inc. (NASDAQ:NFLX) expects to continue growing its subscribers, it seems competition is quickly catching up given the company’s tepid guidance for the current quarter. The company is expecting to add 0.5 million net subscribers domestically and 2 million internationally. However, the guidance falls short of Wall Street estimates that call for domestic subscriber growth of 0.6 million and international subscriber growth of 3.5 million.

Takeaway

Netflix, Inc. (NASDAQ:NFLX) has a nice business plan that if successful would unlock massive revenues and profits. But that future prosperity is dependent on how the company copes with growing competition and high cost of doing business.

Neha Gupta

Neha Gupta has been in the financial space for over six years now. Gupta earned her MBA degree from Symbiosis Centre of Distance Learning in 2009 and her passion for finance led her to pursue Chartered Financial Analyst (CFA) course. She has successfully completed Level II of her CFA. She is a veteran in article writing, which is depicted in her numerous pieces published on SeekingAlpha, Nextiphonenews, InsiderMonkey, MarketWatch, and Techinsider. Her crisp and eloquent writing finds its best place in Researchcows, where emphasis is given on developing rich content for various websites, products, business plans, trainings, and book writing.

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