Chris Umiastowski is the growth investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
Last week I jumped on a plane with my wife and kids to escape the cold weather and enjoy some Caribbean sunshine. Being self-employed makes taking vacations very flexible, but it also means having to accept doing some work during vacations. Not that long ago, I would have needed to pay for expensive cellular data roaming to stay connected. But over the past three years I've started to notice that high-quality WiFi is practically ubiquitous at Caribbean resorts. These hotels used to seem like the only places on the planet to not have proper Internet.
High-speed broadband is not important to read the news, but it is required for video. Late on Wednesday afternoon, while my kids were having a siesta to recharge for an evening of fun, I wanted to catch up on the Netflix Inc. fourth-quarter earnings report that was released one day earlier. Unlike the traditional boring quarterly conference call, where the company reads its press release and then takes a few audio-only questions from analysts, Netflix hosts an earnings video interview with analysts. They broadcast it live in high definition and archive it on YouTube.
Only three months ago, Netflix posted weaker than expected third-quarter subscriber growth and the stock lost 20 per cent of its value. But last week, Netflix reported strong results (including subscriber growth) and the stock has come roaring back. But the real story, in my opinion, is not the reported numbers. Much more important is how Netflix plans to accelerate its global launch. The company has gained a lot of confidence from its launch of the streaming video service in the first 50 markets that it now wants to expand to about another 150 markets within two years. In case you don't remember the company's stated plan, it was to reinvest most of its profit in launching new markets.
Since Netflix is achieving profitability in new markets fairly quickly, it makes sense to accelerate the remaining global launch. Last quarter, Netflix announced that it was profitable in Canada and about 40 other countries only two to three years after launching in each of these markets. With results like this, I think the company's decision to invest more, sooner, is a no-brainer. It may also simplify their business. Instead of negotiating licences for content on a country-by-country basis, Netflix is now talking about global licence deals. This is something that only makes sense when you have global scale, which Netflix is quickly achieving. This same global scale is what justifies their decision to ramp up production of Netflix original series and movies.
Netflix stock seems expensive if you only look at near-term forecasts. Analysts think the company will earn $5.92 (U.S.) a share next year, putting the price to earnings ratio above 70. But when I look at the stock I still see enormous long-term potential. Netflix penetration among Canadian and U.S. homes is fairly high, but they have only scratched the surface in many of their newer markets and the accelerated launch plans only add to this growth potential.
While there is plenty of competition in the space, Netflix is the largest and most global player in online streaming. My investment strategy is to bet on leaders.
This quarter, Netflix should surpass 60 million subscribers, but I think it could exceed 200 million paying members before the end of this decade. At a 20-per-cent profit margin, this translates into $4-billion in annual profits by 2020 with more runway for growth into the next decade. At a market capitalization of $26-billion today, I like the prospects for shareholders.
Here's some food for thought: What will Netflix do once they've finished their global expansion? Surely it won't be nothing. Can they add a subscription business for video games or reach into some other adjacent market? I don't think most Wall Street analysts are thinking that far into the future, but I am and I hope you do too.
Disclosure: The author owns Netflix both personally and in his Strategy Lab model portfolio.
Chris Umiastowski