On Monday evening, Netflix (NFLX) announced its quarterly results. The results were a little better than the analyst expectations but not good enough to impress the investors who had built so much optimism in the company's stock price in the last year and a half.
Many investors were hopeful that the company's exclusive show "Arrested Development" would attract a lot of new members, and it probably did play a role in the addition of many members but the number of new members wasn't as high as many would have hoped.
During the quarter, 630,000 new members were added to Netflix whereas some investors were hoping the number would be closer to 880,000, which was the high-end of the company's guidance at the end of the last quarter.
In the U.S., the number of active members was pretty close to 30 million at 29.8 million. Outside of the U.S., the company enjoys 7.75 million paying members, and this number increased by 605,000 in the last quarter. Combining the U.S. and international markets, Netflix has added 1.23 million members in the last quarter.
The company enjoys a huge market share in paid content on the Internet; however, the competition has been gearing up and pressuring Netflix in many ways. Up until a few years ago, the company was almost unopposed and it could add members at a very rapid rate. After several companies such as Hulu and Amazon joined the race in order to get a piece of the pie, the growth rate of Netflix has somewhat slowed down in the U.S. Apple is barely getting its feet wet and some cable companies are testing their own streaming, which may pressure Netflix further. Moreover, Google's YouTube is testing a model where users pay a small fee to view some movies but the company's library mostly consists of older movies for the time being.
As for Netflix, the company's DVD business is much more lucrative than its streaming business. Unfortunately, as the company adds more members to its streaming side, it's been shedding members in the DVD side. Netflix's DVD business currently has 7.5 million members after it lost 475,000 members in the last year. Interestingly enough, Netflix wants to push people from its DVD business to streaming business because it wants to focus its resources in the streaming business where it sees a lot of future, even though the business has razor-thin margins. The management of Netflix is willing to let go of a higher-margin business in order to pursue a lower-margin business, which should be a red flag for the investors. I understand that most customers prefer streaming rather than DVD deliveries because it is much easier; however, the company's DVD library is much, much richer than its streaming library. The number of titles in Netflix's streaming library is a fraction of the number of titles in its DVD library.
Netflix is also looking to create its own content such as TV shows and movies in order to attract more members. While I'm sure that most members appreciate having exclusive content, there isn't enough data to tell whether those shows can actually move the needle for the company. We don't know how many of the company's new members decided to sign up because of the Netflix exclusive shows. As time passes, it will be interesting to see the company's return on investment rates for those exclusive shows. The CEO of the company Reed Hastings acknowledged that "Arrested Development" added a "small but noticeable" bump in the number of subscribers.
In the quarter, Netflix generated $1.07 billion in sales, up from $889 million in the same quarter a year ago, which signifies an increase of 20%. The company's net income rose to $29 million, up from $6.16 million in the second quarter of 2012.
In the next quarter, Netflix expects to increase the number of American subscribers by 700,000 to 1.2 million and the midpoint falls to 950,000, which is below the 1.16 million members added in the third quarter of 2012. Outside of the U.S., the company expects to add between 550,000 and 1.25 million members and the midpoint falls to 900,000, which is above the 690,000 members added in the third quarter of 2012. Basically Netflix expects growth to slowdown in the U.S. and accelerate overseas.
My last Netflix article was published last year when the company's share price was in $70s. Back then, I said that I didn't mind initiating a position with the company because it seemed like Netflix had bottomed out. I didn't buy any shares of the company, which I regret now. As the company currently trades at levels above $250, I don't think Netflix is a good deal anymore. Even though the company was able to grow its earnings by 6 fold in the last quarter (compared with the same quarter a year ago) it is still trading for a very high valuation. In the last 4 quarters, Netflix earned 81 cents per share, which is a very tiny compared with the company's share price of $250. If every person in the U.S. was a paid member of Netflix, its price might be justified but this is not the case. For Netflix, so much growth is already baked-in the price and there might not be much growth rate once the company reaches a size that justifies today's share price. Netflix operates in a low-margin business and once the competition pushes in, the margins might fall even further.