30% Upside for Netflix From Falling Subscriber Acquisition Costs

Nov. 8.10 | About: Netflix, Inc. (NFLX)

Netflix’s (NASDAQ:NFLX) marketing costs increased 39% to $81 million in the latest quarter from $58.5 million in Q3 2009 [1]. Netflix continues to win new subscribers despite competing with a host of other online and offline video services offered by players like Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOG), Comcast (NASDAQ:CMCSA) and Time Warner Cable (TWC).

Furthermore, Netflix’s subscriber acquisition costs (SAC), a measure of marketing costs per new subscriber acquired, continue to drop. SAC dropped 26% from $27 to $20 per subscriber from Q3 2009 to Q3 2010 due to a significant increase (88%) in gross subscriber additions. If subscriber growth continues to outpace growth in marketing spend and Netflix is able to maintain a low churn (subscriber loss), overall SG&A expenses (including marketing) as a percentage of Netflix’s gross profits could decline and provide 30% upside to the current Trefis price estimate of $106 for Netflix’s stock.

The Impact of Falling Acquisition Costs

Given the increase in subscriber growth, we believe that customer sign-ups are being driven by more than just an increase in advertising. Factors driving higher subscriber growth include: 1) word of mouth from Netflix’s growing subscriber base, 2) increased exposure from Netflix’s presence on Xbox, Wii, iPad and iPhone, 3) the buzz around Netflix’s growing streaming video library, and 4) Blockbuster losing customers to Netflix.

If this organic growth continues as marketing costs grow slower in coming years, we expect sales, general and administrative (SG&A) expenses as a percentage of Netflix’s gross profits to decrease. Since marketing expenses account for around 80% of Netflix’s SG&A costs [2], slower growth of marketing expenses relative to revenues and gross profits will reduce SG&A as a percentage of gross profits noticeably.

Trefis currently estimates SG&A as a percentage of gross profits to remain level at around 43-45% of gross profits [3] through the Trefis forecast period. If this were to decline to 30% by the end of the Trefis forecast period, this would increase Netflix’s profitability and add just over 30% to the current Trefis price estimate for Netflix.


  1. According to Netflix 3Q 2010 10-Q
  2. Q310 10-Q
  3. SG&A / Gross Profits

Disclosure: No positions