How Much Farther Can Netflix Grow?

| About: Netflix, Inc. (NFLX)


Netflix narrowly missed 2Q14 earnings estimates, but topped the same quarter last year.

The company is fighting hard to maintain viewing quality despite a lack of infrastructure to support so much streaming for its viewers.

If the infrastructure to support higher volumes of video streaming is not in place soon, Netflix’s subscriber numbers will level off - and with it profits.

Netflix (NFLX) has been going head to head against big cable over the past few months - and it shows. The company reported earnings on Monday. Earnings per share for the 2Q14 swelled to $1.15, falling just shy of average analyst estimates of $1.16 per share but more than double the same quarter last year.

Total revenue for the quarter was $1.34 billion, narrowly topping predictions of $1.33 billion, and soaring up over the same quarter last year of $1.07 billion. The news, while not quite meeting analyst expectations across the board, was enough to send the stock up 1.5% in after hours trading to roughly $458 per share off the day's close of $452.

Now for the bigger question - is Netflix worth your investment going forward?

Growing Markets

Netflix continued to expand its subscriber base in 2Q14, adding 1.69 million streaming subscribers, which was considerably higher than its own estimates of 1.46 million. This brought Netflix's total streaming subscriber base to 50.05 million, including more than 36 million streaming subscribers domestically. That is over 11% of the US population, which is especially surprising given how many people share subscriptions.

Netflix is growing markets through award-winning original programming (it got 31 Emmy nominations this year, more than double the 14 it received last year) and some very unique marketing strategies - namely set-top boxes.

Subliminal Advertising

Netflix has grown to be a household name and the culprit isn't television commercials, magazine advertisements, or radio spots - although those do exist, especially in foreign markets.

Quite literally, Netflix is everywhere - and that is a big part of its strategy. The ubiquitous streaming app is available on tablets, mobile phones, and many set top devices such as Roku. It also comes standard on several set top boxes including Apple's (AAPL) Apple TV as well as a range of Smart TVs. In other words, when you plug in most Internet-connect video viewing devices, Netflix is pre-installed.

This bit of subliminal advertising lowers the company's barrier to entry and it serves to inform would-be subscribers that the company exists - no advertisements necessary.

In addition, Netflix has been expanding its reach using multichannel video programming distributors (MVPDs) such as Tivo. The push helps the MVPDs drum up pay-per-view programming, so its a win-win situation.

Will the infrastructure be there?

The bigger question for a would-be investor is whether the infrastructure will be there to support so much video streaming. This is where the issue of "net neutrality" comes into play.

In a nutshell, the issue is that there are more people streaming video than the Internet providers can effectively manage, and it's not clear who will ultimately shoulder the bill for the infrastructure necessary for viewers to avoid the dreading buffering wheel.

In order to pay for the upgrades necessary to support such a high volume of video streaming, many Internet providers are saying that such investment would be expensive and they want to pass the costs on to either video streaming companies such as Netflix, the consumers, or a combination thereof. Their reasoning is that Netflix and Google's (GOOG) YouTube account for over half of all Internet traffic in the US, and that those companies should pay to accommodate their respective customers.

Netflix is essentially against this.

"Our focus on strong net neutrality, including interconnection, is about preventing large ISPs from holding our joint customers hostage with poor performance to extract payments from us, other Internet content firms, and Internet transit suppliers such as Level 3 and Cogent," says the company in its 2Q14 letter to shareholders. "Our policy goals are for the FCC to not sanctify paid prioritization, and for the DOJ/FCC to block the merger of Comcast/TWC, or at the very least, to require as condition to approving the merger that the combined entity be prevented from charging for interconnection."


In any case, big changes are going to be coming to streaming Internet - customer usage demands it. Realistically, there are bound to be those who are willing to pay more to lock in content, to never have to buffer.

The question important to investors is whether Netflix will be able to grow much larger until the infrastructure is there to ensure a quality video streaming experience for all its customers. If not, subscribers may become frustrated with Netflix service and discontinue service.

There is only so much "buffering" a person can handle.

Investors in Netflix would do well not to buy into the momentum, but wait until the company dips. Expect a leveling off as domestic markets and Internet infrastructures become saturated. The company's share price will mature and stabilize going forward, at least until the issue of available Internet capacity and infrastructure is addressed.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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