Netflix Jumps After Strong Results, Will The Growth Sustain?

Netflix's ( NFLX ) stock jumped close to 18% in after-hours trading on strong results and an even better outlook. It came as a surprise that the company doesn't expect net subscriber additions to slow down in Q1 2014. However, the second quarter could experience higher seasonality and weaker growth. Overall, Q4 2013 results showcased that Netflix is delivering on its promise of improving its domestic streaming contribution margins by 400 basis points annually. It also is pushing on better technology and it is still in the middle of the S-Curve of market adoption - suggesting that the subscriber growth in the U.S. may remain healthy in the near term. At the same time, the company acknowledged that competition is increasing domestically and Verizon's successful challenge against net neutrality could potentially impact its profits going forward.

Our take is that while the current results are very encouraging, we may see a notable impact of competition in 2014 and growth could come down in the latter half of the year. Besides, growing streaming content obligations, which are off the balance sheet, are certainly not to be overlooked. We are currently in the process of reviewing our price estimate for Netflix in the light of recent earnings and will have an update ready soon. Our current price estimate for Netflix stands at $232 , implying a discount of about 40% to the market price.

See our complete analysis for Netflix

Domestic Business Trajectory Still Shows Strong Signs

Netflix gained 2.33 million domestic streaming subscribers in Q4 2013, which was near the high end of its guidance and implies year-over-year growth of nearly 14%. This can be attributed to the continued uptake within the online streaming industry, the company's improving content library, and its enhanced marketing campaigns. During the quarter, the company launched additional original programs, including: 1) a second season of Lilyhammer ; 2) the first original animated series for kids, Turbo F.A.S.T. ; and, 3) an original comedy specials. The breadth and freshness of the content has improved over the last few quarters and is a major differentiator for Netflix against its competitors. The chart below shows the cumulative domestic streaming membership over the last 14 quarters. The data before Q3 is that of total domestic members since the company started offering 'streaming-only' service after that. Hence, there is a slight dip in the count but the overall growth trajectory has remained the same.

Netflix's Domestic Streaming Subscribers (Thousands)

The above chart tells us that membership growth hasn't started moderating yet. It appears that even though Netflix has recycled through a majority of potential customers in the U.S., many of them are joining back again to access exclusive content. The fact that Netflix's original shows have been critically acclaimed and nominated for several awards point towards their quality. THis in turn acts as a marketing point for the company. In Q1 2014, Netflix expects to gain roughly 2.25 million subscribers, which again represents a healthy growth over the same period in 2013.

To add to that, the company is experimenting with several tiered structures and may implement tiered pricing in the future. However, the change, if it happens, will not impact current subscribers and, hence, the revenue impact will be small initially. Nevertheless, this opens up another area for Netflix to grow its profits, if subscriber growth stalls in the event of market saturation or increased competition.

The Risks That Accompany This Rosy Outlook

The problem with Netflix's business is that it is very easy for customers to join and leave. This suggests that any wrong move, or significant strides by a competitor, could lead to sudden brakes on its growth. As a result, it warrants a higher risk factor as compared to other established businesses where there are enough forces at work to discourage customers from changing the service. There is no doubt that competition is growing. An analyst from Macquarie recently stated that Amazon ( AMZN ) has confirmed it has over 20 million Amazon Prime members globally. The company has been competing with Netflix for a long time in the online streaming business but had been mute about its membership base. The revelation suggests that it has become a force to reckon with, and could spell trouble for Netflix in the coming quarters. Amazon has also started taking advantage of its distribution capabilities to expand its streaming business and plans to sell set-top boxes of its own. This could have a mitigating impact on Netflix's growth.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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