As Netflix (NFLX) announced its results for the fourth quarter and full-year of 2013, investors are cheering the results and the stock is seeing a rally of 16% in the after-hours. It looks like Netflix either met or passed every goal it set for itself last quarter and the investors have every reason to cheer. On the other hand, the company's valuation is getting to a point where a lot of future success is already priced in and there is not much room left for error.
The company earned 79 cents per share on revenue of $1.18 billion; whereas the analysts were looking for 64 cents per share on revenue of $1.17 billion. The company came above its guidance in many metrics. For example, it was guiding to add about 2.05 million domestic users whereas it actually added 2.33 million and it was shooting for 23.2% in streaming margin whereas it got 23.4%.
As of the end of December, Netflix had 33.42 million total streaming members and 31.71 million paying streaming members in the US and 10.93 million total streaming members and 9.72 paid streaming members outside of the US, bringing the total numbers to 44.35 million for overall streaming and 41.43 million for paid streaming members.
Netflix saw its domestic DVD subscribers decline during the quarter. The company's total DVD subscribers fell from 7.15 million to 6.93 million and the paid DVD subscribers fell from 7.01 million to 6.75 million. Keep in mind that the DVD segment of Netflix is the highest-margin segment of the company. As of last quarter, the company's DVD segment had a gross margin of 53% compared to the gross margin of 26% in the streaming business. The international streaming business had a gross margin below 1% whereas the domestic streaming business enjoyed a margin of 33%.
When we look at the full year, Netflix saw its revenues rise from $3.61 billion to $4.37 billion, which represents a growth of 21.20%. We might be seeing a slowdown in the company's revenue growth because its revenue growth rate in 2012 was 36.51% (up from $3.20 billion). On a positive note, the company's cost of revenues rose slower than its revenues did, helping the gross margins. During 2013, Netflix saw its cost of revenues rise from $2.63 billion to $3.08 billion, a growth of 17.42%. As long as the company's revenue growth outpaces its cost of revenue growth, it will help the margins, as common sense would say.
The company's marketing costs rose by 8.27% in 2013 after rising by 32.16% in 2012. Netflix did a good job of decelerating its marketing cost growth, which also helped the company's profitability nicely. In 2013, Netflix spent $503.89 million on marketing, up from 2012's $465.40 million. As a result of revenues outpacing cost of revenues and cost of marketing, the company's contribution profit rose by 52.01% during the year compared to 2013. This compares really nicely with 2012's contribution growth rate of 0.51%. As the company's operating expenses rose by 19.45%, its operating income rose by 356.77%, up from $50.00 million to $228.35 million. After taxes and other expenses, Netflix posted a net income growth of 555.33%, up from $17.15 million to $112.40 million.
Domestically, the rate of growth for Netflix was 24.50% compared to international growth of 78.57%. Basically, the international growth rate was triple the domestic growth rate. Netflix has been investing heavily into international growth since it already has very strong market penetration in the US, but this has hurt the company's margins in the short term. This trend may continue for the next few years, after which the company's international margins should recover. While internet streaming is picking up pace domestically, Netflix is facing some serious competition such as Hulu, iTunes, YouTube and Amazon Instant Video. All of these streaming websites are seeing double-digit growth, and some are growing even faster than Netflix. For example, during the conference call, it was mentioned that Hulu was able to grow its paid subscribers by 65% in 2013 (despite 2 CEO changes that occurred through the year).
The company hopes to raise $400 million in long-term debt in order to take advantage of a low-interest environment, in addition to its existing $500 million debt. The new debt total will be $900 million and this is not expected to hurt the company's operations. Netflix will be using this new funding on growing internationally and getting more content. Netflix currently has roughly 60 million outstanding shares compared to the 56 million shares it had at the end of last year. The company is authorized to issue more shares in the near future and this may increase the dilution by a little bit.
In the first quarter of 2014, the company expects to see growth figures very similar to what it saw in the fourth quarter of 2013. The domestic margins are expected to be around 24.9% and the international margins are expected to be around -15.7%. Including the DVD business, Netflix expects to earn $48 million or 0.78 per share in net earnings in the first quarter of 2014. The company also expects to add about 2.25 million new members during the quarter.
Due to the strong rally in the after-hours, Netflix is now worth $393 per share, which gives the company a market cap of $23.58 billion. Netflix earned $112.40 million last year and it is expected to earn anywhere between $150 and $200 million this year. Even the most optimistic outlook gives the company a forward P/E ratio of 118 while it enjoys a trailing P/E of 209. The company will have to increase its net earnings by about 30-40% with perfect execution every year for the foreseeable future in order to justify today's valuation. The company is richly valued and a lot of future success is already priced in.
Still, Netflix might not be a good short candidate because the stock is very volatile and the slightest good news can move the stock up in double-digits.