Netflix: 2008 Outlook

Now that Netflix (NASD: NFLX) has reported their 2007 results and given their outlook for 2008, I thought it would be a good idea to take a look at this company’s past performance and their 2008 outlook. After doing this, I will try to calculate several probable values for Netflix in a separate article.

Subscriber and Revenue History

Netflix reported total subscribers of almost 7.5 million and revenue of over $302 million in the fourth quarter of 2007. Both were at the upper end of their previously guided range. Below are some tables outlining the past several years of subscriber and revenue growth.

There are several items that I think are important in these tables. First, it is obvious that subscriber and revenue growth slowed dramatically in 2007. Just looking at the fourth quarter of the past three years, year-over-year subscriber growth went from 60% in 2005, to 51% in 2006, then dropped to 18% in 2007. Comparing year-over-year fourth quarter revenue growth, you can see it went from 34% in 2005, to 42% in 2006, then dropped to 9% in 2007. Competition from Blockbuster had a significant impact on subscriber and revenue growth in 2007. Still, Netflix managed to grow subscribers at a 18% rate in 2007 despite this competition.

Next, I began tracking Netflix’s marketing expenses as a percentage of gross profit. Marketing is an investment in future growth for Netflix, but as Netflix backs off their marketing there is a corresponding increase in their earnings and cash flow.

The last item that I want to note about these tables is that there is a certain amount of seasonality in their subscriber and revenue growth. I’m going to use certain assumptions to build a quarter by quarter look at Netflix’s 2008 guidance.

2008 Outlook

Netflix provided the following guidance in their most recent earnings report.

First Quarter 2008

* Ending Subscribers of 7.85 - 8.05 million
* Revenue of $323 - $328 million

Full Year 2008

* Ending Subscribers 8.4 - 8.9 million
* Revenue of $1.3 - $1.35 billion

Based on the seasonality of Netflix’s revenue and subscriber growth, I’ve constructed the following table.

If Netflix is able to meet their revenue and subscriber guidance in 2008, it will be a very good year for them. Year-over-year subscriber growth of 16% would be a nice number for the company. Revenue growth of 17% is not something to disregard. Let’s look at a chart of revenue and subscriber growth. This chart starts in the first quarter of 2005 and ends with the fourth quarter of 2008.

Conclusion

As I mentioned in a previous article and as demonstrated in the tables above, the transformational growth that Netflix reported in the past now seems to be over. Management is no longer discussing significant additional market penetration. Gone are the discussions of a “tipping point” following video store closings. Kiosk rentals and other ways of accessing media are filling just as much of the retail void as Netflix.

Despite all of this, Netflix may be on a path of steady growth for the next few years. If this is the case, shares of Netflix may be cheap and worth consideration. I will look at the valuation of Netflix in my next article.

Comments

[borisb]

i agree but at the same time this is simply a group of warehouses stuffed with second hand DVDs and the company systemically shoves catalog crap on trusting customers. thats abusive.

[vraj]

Good analysis by Dan. I wish to point out that though Netflix and Blockbuster fall under Movie rental domain, their distribution models are totally different. This scenario is similar to comparing Amazon (for just books and media) with Barnes & Noble. The distribution channel plays a very important role for Netflix and their Wow factor has been "No Late Fees". Reed Hastings' trump card was avoiding late fees and ability to keep DVDs as long as you want. Blockbuster literally pulled the rug under Netlix when they eliminated late fees in 2006. Ever since this change happened, Netflix has been losing customers. There is nothing unique about Netflix anymore. I have used both services for sometime and have stopped Netflix now. The main attraction with Blockbuster is that I can get DVDs via mail and can return the media to a nearby store and get another one for free. What more can one ask for? The huge number of Blockbuster stores around the country is a big advantage for them and attracts significant foot traffic into these stores. Netflix cannot match Blockbuster's reach with just online distribution. The planned release of LG Set Top Box for Netflix movie distribution will fail because of "Set Top Box Fatigue" among consumers. I don't want another stupid box in my living room rack with wires running around. 2008 will be a tough year for Netflix - there is nothing unique about their business model and I can get the same service with a wider selection at Blockbuster+mail-in DVD and Hollywood stores. Is Netflix a prime target for takeover? Look out for Jeff Bezos in 2008.