Can Netflix Double Again? Only With Adequate Growth and Cost Cuts

Apr.13.10 | About: Netflix, Inc. (NFLX)

Netflix (NASDAQ:NFLX), the online movie rental company, has seen its stock price double in the last 7 months in part due to continued fast growth in the company’s subscribers. In order for Netflix’s stock to double again, we believe that the company will need to increase its subscriber growth numbers as well as reduce costs. Below we discuss some of the factors that can make a difference to Netflix’s growth rate and continue driving its stock up.

1. Netflix Will Need To Bring Newer Movies Online and Expand Movie Catalog

Netflix’s online streaming service, which is free to subscribers of its DVD rental service, helps the company to attract new customers. Streaming service alone, however, is not very valuable due to the limited selection of, primarily older, content. We believe that Netflix will gain subscribers at a much faster pace if it can significantly improve its inventory of new release films available for streaming.

Netflix has already expanded its streaming to reach multiple electronic devices like gaming consoles (Xbox, Wii), the iPad and soon the iPhone. The company is well-positioned to drive future subscriber growth and improve customer retention. Wide distribution alone won’t be sufficient though. Netflix needs to bring more movies and shows online in order to help drive the consumer shift to online viewing.

You can modify the forecast above to see how Netflix’s stock can be impacted if it were to gain subscribers at a faster rate than we anticipate.

2. Faster Internet Connections Will Help Netflix to Stream Higher Quality Videos

Although Netflix’s streaming service is available to big screen TVs, the video and audio quality of streaming has to be comparable to the quality of DVDs and Blu-ray discs in order to for more subscribers to use online streaming rather requesting the DVD. Faster broadband internet connections that provide more bandwidth will help Netflix to stream higher quality content.

Although the speed of broadband is not in Netflix’s control, the company will benefit in the long-run as cable and fiber-optic compete to provide faster internet connections to consumers.

3. Customer Shift Away from DVDs To Streaming Will Help Netflix Reduce Costs

If Netflix can make its online catalog attractive to consumers, its dependence on DVD shipments will decline. Although Netflix’s overall bandwidth costs will increase from streaming more films, the reduction in postage and packaging costs for mailed DVDs and DVD shipment center costs will more than compensate for increased bandwidth costs.

We estimate that online movie delivery is 10x less expensive for Netflix compared to sending DVDs by mail. This will result in overall cost savings for the company. A reduction in costs combined with subscriber growth will help Netflix create additional value and drive stock growth.

4. Combating Competition, Especially from DVD Rental Kiosks, a Priority

Redbox, a DVD rental kiosk operator and a primary competitor to Netflix, provides DVD rentals at a cost of $1 per day. Such DVD kiosks are very attractive to consumers as they provide low priced rentals and stock new releases that are in demand.

DVD kiosks like RedBox are in competition with Netflix to make new releases available as soon as possible. In an effort to make new releases available soon, Netflix has signed a deal with Warner Brothers whereby new releases from the studio will be available to Netflix customers after a 28-day period. In comparison, kiosk companies like Redbox are renegotiating deals with movie studios to continue making new releases available to customers faster.

Hence competition with DVD kiosks makes it necessary for Netflix to find new ways to attract consumers.

For additional analysis and forecasts, here is our complete model for Netflix’s stock.

Disclosure: No positions