Netflix: Q4 2013 Earnings Review

Netflix Q4 2013 earnings review

Netflix (NASDAQ:NFLX) the most popular online video streaming service provider came out with its Q4 2013 and full year 2013 results yesterday (Jan 23) after market close. The user numbers were in line with our estimates but they did surprise us positively on the earnings front. The company turned in a blowout quarterly performance which resulted in the stock gaining close to 17% in after-hours trading following the earnings call. Following our earlier preview on the Netflix Q4 2013 earnings, we today update our outlook on the company based on the actual Q4 numbers.

Q4 2013: A blowout quarter by any metric

Netflix Q4 2013 performance was an undeniably strong quarterly performance on all fronts. The company reported a higher than expected increase in the number of subscribers. Another positive was the 4.9% Y/Y increase in the company’s overall contribution margin. The revenue growth coupled with margin expansion continued to drive earnings in Q4 2013.

Netflix quarterly earnings per share

The table below summarizes Netflix’s Q4 2013 performance.

Q4 2012 Q4 2013 YoY change
Domestic
Total subscribers 27.15 33.42 23.1%
Paid subscribers 25.47 31.71 24.5%
Revenue 589 741 25.8%
Contribution margin 19.2% 23.4% 4.2%
International
Total subscribers 6.12 10.93 78.6%
Paid subscribers 4.89 9.72 98.8%
Revenue 101 221 118.8%
Contribution margin -103.2% -25.9% 77.3%
DVD
Total subscribers 7.15 6.93 -3.1%
Paid subscribers 7.01 6.75 -3.7%
Revenue 255 213 -16.5%
Contribution margin 50.1% 51.7% 1.5%
Total Revenues 945 1,175 24.3%
Contribution margin 14.4% 19.3% 4.9%

Streaming business

Netflix reported a total subscriber base of 43.35 million for its streaming business, a growth of 33% over the year ago quarter. The growth was driven by a 23% growth in the domestic market against a growth of 78% in the international subscriber base. The paid subscriber base saw an increase Y/Y of 36% with the total paid members reaching 41.43 million. The domestic segment saw an increase in the contribution margin of 4.2% even as the international segment’s drag on the overall performance of the company reduced with contribution loss margin improving by 77% over Q4 2012. The improvement in margins can be attributed to the effect of scale, which is a result of the new additions to Netflix’s subscriber base. The international margins will also continue to improve as the company expands into newer geographies achieving efficient scale of operation in its international operations. Another reason for the margin improvement was the company’s focus on in-house produced content, which complemented licensed and sourced content. We expect the company’s international operations to breakeven in late 2014 or early 2015. However that largely depends on the pace of Netflix’s expansion strategy, which can be altered depending on the decisions of the management.

DVD business

The DVD segment saw a 3% Y/Y fall in the number of subscribers accompanied by a 16.5% decline in revenue. However the segment continued to enjoy the highest contribution margin of 51.7%, an improvement of 1.5% over Q4 2012. The segment is expected to take a hit to its profit margins in 2014, mainly on account of increased postal and delivery charges which will be in effect from Q1 2014. The slowdown and margin contraction in the DVD business will be offset by improvements in the streaming business over the coming quarters.

Netflix Full year 2013 performance

The year 2013 saw significant growth in topline as well as bottomline at Netflix. While the growth in subscribers was largely driven by international expansion, the domestic market is far from saturated with the company adding over 6 million US subscribers in 2013.

The company also substantial improvement in profit margins over the year ago periods. The margin expansion was mainly a function of the company’s commitment to in-house developed content and achieving better scales of operation in the international as well as domestic markets. The company will continue to focus on original in-house content with a number of sequels for their shows lined up for release during 2014. The international expansion,  set to pick up pace in the second half of 2014 following the successful Dutch launch Q4 2013, will also drive international revenue growth in 2014. The table below shows the company’s performance for the full year 2013 in comparison to full year 2012 performance.

2012 2013 YoY change
Revenues 3,609.3 4,374.6 21.2%
Gross Margin 27.2% 29.5% 2.3%
Operating Margin 1.4% 5.2% 3.8%
Net Income Margin 0.5% 2.6% 2.1%
Diluted EPS 0.29 1.85 538%

Conclusion

The company did deliver a record quarter and with all due credit for the stellar performance, as investors looking to enter into positions in Netflix, an important question to be asked is what is the right price? The answer to that question lies somewhere in the grey and depends on a number of factors. The most important factor is an investor’s risk appetite and expectations on future growth. We, at Amigobulls, believe that the company’s current valuation (P/E of 210 based on pre market price at time of writing, $390) is overpriced considering the company’s growth potential up to 2015. The small current earnings base combined with the geographic expansion and margin expansion will lead to extraordinary growth in earnings over the next two years. However, the company trades at a 2 year forward P/E multiple of 31 assuming that the company will grow earnings at 250% and 100% Y/Y, in 2014 & 2015 respectively. While the company is a great business, getting into the stock at its current price levels implies huge risks and will most likely not result in extraordinary returns.

Keep reading here for our latest updates from the internet industry. On a parting note, as investors it would be prudent to remember that the earnings season brings with it a lot of excitement and activity in the markets. At this time it would be better to let your rational self make the judgement rather than getting caught in the wave of excitement. Find that too difficult to follow? Relax and sit back in your chairs while our technology and finance experts pick out the right stocks with maximum safety and significant upside potential. All you have to do is login and check our top stock picks from the internet sector. Happy investing.

To see Netflix stock price movement, please click here: Netflix stock charts)

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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