Netflix (NFLX, Financial) shocked a lot of investors when the company reported less than forecasted subscriber addition during the first two quarters. The slowdown resulted in the stock plunging Ă‚ after the earnings were reported in April and July. Netflix is now down more than 17% in the last one year and, despite the downward correction, the stock is still trading at 5.4 times sales.
The more than 47 million members in the United States helped generate revenues of $1.161 billion during the second quarter of this fiscal, accounting for nearly 61% of their total worldwide streaming revenues of $1.966 billion. Though international membership has been growing along with revenues, it will be many years before overseas revenues can match their home market numbers. What happens in the United States is still extremely important for Netflix and its investors, at least for now.
What’s Netflix’s Real Market Size in the U.S.?
With total memberships in the United States approaching the 50-million mark, the company’s penetration is quickly approaching a plateau. Consider this, of the 130 million households in the U.S., there is an 80% penetration for broadband connections. That leaves Netflix with a potential market of 104 million households and, obviously, Netflix doesn’t have a monopoly on those. They still have to compete with Comcast (CMCSA, Financial), for example, on the cable front and a whole new crop of competitors on the paid streaming video front, such as YouTube Red and Amazon Prime Video (AMZN, Financial) - neither of which are too small to eventually catch up with Netflix’s reach and depth in the United States.
So every subscriber they add from this point on is either going to be an existing customer of its competitors or someone with a newly acquired broadband connection. When you look at it from all those different perspectives, 50 million members translates into high penetration in the company’s most important market.
With already half the potential market in its pockets, growth in the United States will become harder and harder to come by each time they add a new customer to their books. But the worst part is that there could be an additional pricing pressure that comes with further growth, at least with other streaming video companies if not Comcast itself.
How is Netflix Dealing with These Issues?
Netflix, however, has one great advantage over these competitors, which I believe will help the company stay ahead of them. Their collection is much better than other players in the market and they already have a sizable user base in their hands. Google (GOOGL) and Amazon also have the user base, but not quite enough original programming to play in the same league as Netflix. Not yet.
With Netflix continuing to invest heavily in original content, they will manage to stay ahead of their deep-pocketed competitors for the foreseeable future.
The second advantage Netflix has is the company still has a lot of room to increase its pricing, which is much cheaper than what non-streaming users pay for a Comcast connection.
“In 2013, Netflix began experimenting with tiered pricing that charged new U.S. subscribers more for higher video quality and the ability to stream on multiple screens at the same time. As it rolled that out, revenue per subscriber (average revenue per user, or ARPU, is the standard industry term) began a steady rise. At $8.55 a month, Netflix's per-subscriber revenue has a long, long way to rise before it gets anywhere close to cable giant Comcast's $82.41.” - Bloomberg
As user base growth slows down, Netflix will be exploiting its price positioning and keep their revenues moving north. But the biggest problem is not Netflix’s slowing U.S. user base growth. It is the more than 5 times to sale valuation, which requires the company to keep expanding at a crazy pace. The company is entering a more mature stage of its lifecycle and the stock price needs to as well. So if you are an investor, please be ready for that. If you are planning to enter, then be aware that there will be plenty of opportunity to get in. Patience will be the key.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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