Netflix 1Q 2016 numbers - Strong growth but lower than expected

On Monday night we had numbers from Netflix whose content fills our living rooms on a regular basis. Here is a pdf of the Netflix 1Q 2016, Letter to shareholders.

Netflix is not a stock that we talk about very often, so here is a quick run down of the company. The company started in 1998 as a DVD-by mail company. Basically you rent a DVD from them, they post it to you and then when you are finished with it, you post it back to them. Then in 2007 they started their streaming service, expanded the streaming service to Canada in 2010 and now 6 years later they are in 190 countries. The streaming service started with streaming just content from other studios, mostly sitcoms from the 80s & 90s. The big drive now is to produce your own content to attract new subscribers. Their most well know series is House of Cards, very addictive! The service itself isn't very expensive, you can sign up for $8 a month, much cheaper than Dstv, BUT there is no sport.

Revenue for the quarter was $1.95 billion up 24%, of that only $144 million is from the legacy DVD business which is currently fading quickly. Currently their subscriber base is 81 million million people and growing quickly. Over the last 3 months they added 2.2 million new subscribers in the US and 4.5 million International subscribers. The core of their base is still in the US with 47 million of the 81 million subscribers there, the major growth going forward will be the international market. Net income was only $27 million due to them ploughing large amounts into content creation but as the subscriber numbers grow so will their margins. Once the show has been created it is relatively inexpensive to stream it to an extra subscriber.

Going forward the plan to keep subscriber growth on the up is to spend $5 billion in 2016 on content creation and to focus on stepping up production of non-English series. The company has also been working on making their code more efficient, so that people with slower internet connects will be able to also be a client, their efforts have resulted in a 20% saving in data usage.

The reason to buy this company is because they are the leaders in an area of the market that is growing extremely quickly, Netflix expects to add 2.5 million subscribers over the next 3 months. The company is priced for this growth though, currently trading on a P/E 326. More and more people are cutting the cord of their cable or satellite TV subscriptions and moving to streaming. Europe, with a population of around 740 million, has the infrastructure and income to be the next big market to see growth in subscribers. Over the long run there are still around 4 billion people who are not connected to the web, each person coming online is a potential customer.

The stock closed down 13% on Tuesday because the market was expecting subscriber growth of 4.1 million people for the coming quarter instead of the forecast 2.5 million. Clearly high expectations on the company but if you are looking for a small allocation in your portfolio of a "next generation" stock considering buying Netflix. Streaming content is the future, no doubt about that. Will that translate into big profits for the content providers or will the market become too competitive? Only time will tell.