Netflix 3Q - still strong user growth

On Monday we received great results from Netflix. What a story it has been so far, you could even make a series about it. . . Streaming revenues increased 33% year on year, operating income doubled, and they added a record 5.3 million members in the quarter, much higher than their own expectations of 4.4million adds.

Year to date they have added a whopping 15.5 Million subscribers, 29% higher than last year. Most of this growth is coming from the international business. Many countries have just gained access to the wonders of Netflix and users are coming in fast. Estimates predict 115 million global users by the end of this year. The image below highlights the magnificent growth in subscribers over the years.



A streaming business like this may sound like a profit machine with low capital expenses, but that is not the case unfortunately. It is a very competitive industry and the only moat these businesses possess is their content. Netflix plan on spending a massive $7bn on content creation over the next year. Compare that to revenues for the full year of just below $12bn and you realise how much capital needs to be deployed here.

However, I fully agree with this strategy of quality content before profits. If you do not have your clients locked in, they will easily move on to the next provider. The other providers are also getting more stingy with their content. Hence original content is vital. It also gives you pricing power, Netflix increased their prices just before the release of the hit series, Stranger Things Season 2. If you're hooked, an extra $2 a month is worth every penny.

The share price has had a phenomenal run, up 58% so far this year. The forward PE sits at 86 times earnings; expectations are certainly high. I love the business model and I love the company as a consumer. I think the valuations may be a bit stretched at these levels. Mainly because I believe the desire for quality original content will never end and the competition will increase (Apple and Amazon getting on board). Netflix will have to spend big bucks on content as long as they are in this industry.

On the other hand, 115 million subscribers are just a blip in the ocean, of series hungry consumers. I expect subscriber additions to continue to explode over the coming years. There is certainly a place for Netflix in more risk tolerant portfolios.