Netflix’s Stellar Quarter

Till a year ago, Netflix (NASDAQ:NFLX) seemed to be going downhill. A hasty decision by the management to increase prices and split streaming and DVD rental services was not well received by either subscribers or the stock market. Netflix subsequently recalled its decision to raise prices. The decreasing pace of new subscriber additions, rising content costs, and continuing losses incurred on account of expansion in new markets did not bode well for the stock. But within a year, the story seems to have taken a positive turn. In fact, after the announcement of the company’s quarterly results earlier last week, the stock jumped 42% within a day.

Netflix’s Financials

Netflix’s Q4 revenues grew 8% over the year to $945.2 million, ahead of market’s expectations of $934.5 million. EPS of $0.13 was shy of the Street’s targeted earnings of $0.14.

Netflix ended the year with 33.3 million streaming subscribers worldwide and 8.22 million DVD subscribers in the U.S. During the last quarter, it added 2.05 million streaming subscribers in the U.S. and 6 million international subscribers.

For the current quarter, Netflix estimated revenues of $1 billion-$1.03 billion, ahead of analysts’ projections of $969.2 million. It expects to end the current quarter with a profit of $0.00-$0.23 per share. The Street was projecting a loss of $0.07 per share for the quarter. Netflix projects an addition of 1.3 million to 2 million domestic streaming customers this quarter.

Netflix’s Growing Streaming Service

Earlier last year, the news of Netflix’s proposals to hive off the DVD business was not received with much confidence. Management stuck to sharpening the focus on expanding the streaming service in favor of the DVD business. During the past year, Netflix has reduced its DVD subscriber base by 2.8 million, but the streaming subscriber base has grown by more than 5 million.

The recent quarter’s results are evidence of what Netflix had been saying all along: DVD consumers do bring in more profits than streaming subscribers. During the previous quarter, each DVD subscriber generated $16 in profits, compared with $4 for a streaming subscriber. However, every new streaming subscriber added comparatively higher profits as the costs for streaming remained fixed, and with the addition of new streaming subscribers, Netflix’s content costs are divided among an increasingly large subscriber base.

During the past year, contribution margin from the streaming segment has grown from 10.9% a year ago to 18.5%, and Netflix projects an improvement of another 1% point per quarter during the current year.

Netflix’s Content Growth

During the recent quarter, Netflix entered into an agreement with Disney that will enable it to stream Disney movies, including Marvel and Pixar movies, on Netflix. The three-year deal did not come cheap and was estimated to cost Netflix $300 million a year. Starting next month, it will begin exclusive streaming of the political series “House of Cards,” featuring Kevin Spacey and Robin Wright. Other programs scheduled to air soon are the new season of “Arrested Development”and “Lilyhammer,” which is Netflix’s first original series.

Analysts are not fully convinced that Netflix is out of the woods. The growing pressure to improve content will ensure the company keeps investing in big deals such as the one with Disney. After a point, even the growing subscriber base may not be enough, and Netflix may need to increase prices. The last time this happened subscribers jumped ship, and with other options such as Hulu and Amazon increasing their libraries, it is becoming simpler for consumers to move away. Nonetheless, at this point Netflix still has the best selection among its peers.

Netflix’s stock is trading at $169.12 with a market capitalization of $9.4 billion. It touched a 52-week high of $172.68 last week. It is still trading significantly below the highs of $304.79 it reached in July 2011.