Netflix: Issues And Opportunities

Feb.21.14 | About: Netflix, Inc. (NFLX)

The growth in stock price for Netflix (NASDAQ:NFLX) has been astonishing over the past few months. The stock is up over 18% since the start of the year and over 132% during the last twelve months. Netflix's business is clearly booming and its revenues and profits are the evidence of the growth. Unfortunately, some issues with the ISPs have caused the service to suffer recently. If the issue remains, it can have an unfavorable impact on Netflix and the subscriber growth may slow down. Furthermore, the company has plans to expand into Europe over the next twelve months, which should enhance its global presence and support its revenue growth. Let's look at these factors in detail.

Issues with the ISPs

Recently, Netflix service has been suffering from lagging speed in service and its users are disappointed. Most of the customers are facing slow buffering speed and some have also complained about the quality of the video. The drop in the speed has caused the subscribers to suffer. The ISPs are blaming Netflix for not spreading out the delivery of its traffic in a more efficient way. However, on the other hand, Netflix says that the company plans out its programming across the internet in the best way possible. There have also been some allegations about the ISPs intentionally "throttling" the speed, which were denied by these ISPs.

Verizon (NYSE:VZ), Comcast (NASDAQ:CMCSA) and AT&T (NYSE:T) have reportedly argued that Netflix should pay more for their service as it uses larger bandwidth. On the other hand, Netflix has been trying to bring ISPs onboard with its "Open Connect Program", which will pump Netflix streams straight to ISPs resulting in better speed and quality of videos. Netflix accounts for over 32% of the heavy internet traffic in North America. Since it uses Heavy bandwidth, ISPs are looking at a way of squeezing cash from Netflix. However, net neutrality rules prevent ISPs from blocking or slowing down traffic to websites. There are fears that lax Federal Communications Commission rules may change the structure of video streaming over the internet going forward. However, FCC is working on new regulations which should prevent the ISPs from charging fees to Netflix and other companies. The new regulations should be in place by late spring or early summer.

Growing Business and Margins

Netflix has recorded impressive trend in its gross margin over the past year. In 2012, the gross margin was roughly 27% while in 2013; it has increased to 30% giving the company 3% more spread in profits. In the third quarter, the gross margin was 28.5% while in the fourth quarter it increased to roughly 31%. As the revenues of the company are rapidly increasing, we can expect the gross margin to remain strong. Furthermore, the company is planning on expanding in Europe during the current year, which has caused the European media companies to panic. Some of the companies in Germany, Italy and France are already offering packages as low as €10 ($13.68) per month - Netflix will have to spend substantially to gain the market share in Europe as the local companies look set to compete with Netflix, and these companies are already developing the strategies to preserve their positions in their respective markets. As a result of these increased costs, we might see a dip in earnings growth over the next few quarters; however, I believe the opportunity to grow its subscribers base will make up for the costs in the long-term.

Conclusion

As the stock has gained massively over the past few months, there are concerns that the stock may be ready to pull back a little. However, even if that happens, it will be temporary, in my opinion. The stock price for Netflix has been mainly moving up due to the company's ability to grow its market share, revenues and subscribers base. There is still room for the company to grow subscribers base in the domestic market, and with the global expansion, the growth rate in subscribers will only get better.

The change in the strategy from the prospective competitors in Europe indicates that these companies are threatened by Netflix, and the expectation is that Netflix will receive a warm welcome in Europe. As a result, I am optimistic about the future revenue growth and increase in the subscriber base. However, as I mentioned above, we might see a small decline in earnings due to the increased expenses in Europe.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. IAEResearch is not a registered investment advisor or broker/dealer. This article was written by an analyst at IAEResearch and represents his/her personal opinion about the companies mentioned in the article. The article is for informational purposes only and it should not be taken as an investment advice. Investors are encouraged to conduct their own due diligence before making an investment decision. I am not receiving any compensation (other than from Seeking Alpha) for this article, and have no relationship with the companies mentioned in the article.