If NFLX = HBO What Does That Mean For Growth?

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$NFLX is up 25% today after reporting that the company grew domestic streaming subscribers by 2m last quarter.  In total, the company now has about 31m unique domestic subscribers (including the DVD business) and 7.1 million international subs.  On the domestic front, this means that about one in three households now has a Netflix subscription.

The subscriber growth seems to validate Netflix’s strategy to make HBO its chief competitor, and with these subscriber numbers $NFLX is already almost all the way there.  Including Cinemax, HBO has 41 million domestic subscribers, a number that has been reasonably steady for the last decade and implies that this is somewhere near the saturation point for premium entertainment subscribers in the US.  Netflix is now about 25% below that mark, which is equivalent to approximately five more quarters of growth at the current pace.

Given that Netflix could be stepping closer to the saturation point in the US, and that the share price is not at all reflective of current cash flows, NFLX shareholders will increasingly need to look to other avenues for growth.  These could include:

1) International:  The good news is that there are probably plenty of subs to be had.  According to $TWX’s annual filing, the Home Box Office segment has about 73m international subs, or 114 million total subs worldwide.  That’s 10x as many as NFLX’s current number.  (The international segment may not be an apples to apples comparison though, since many of those subs are tied up in JVs and non premium channels, and Time Warner doesn’t break out the segment very clearly).

2) Domestic:  Of course it’s also possible for NFLX to surpass HBO in terms of domestic subscribers, but it’s worth noting that now that NFLX is allowing 4 simultaneous streams for a premium price of $11.99 the company is effectively condoning shared accounts and therefore may limit its subscriber growth.

3) Price increases: Netflix shareholders could theoretically also get a boost from service price increases over time.  HBO charges around $16 per sub, while basic Netflix is at half that number.  HBO does have to split some of this revenue with the cable providers though.

Still, NFLX shareholders should keep in mind that on HBO’s subscriber base, TWC’s network subscription revenue is $8.6B.  Because of the opacity of Time Warner’s financials, it’s difficult to know for sure what the margin is on this revenue (the “network” segment which has $14.2B in total revenue has a 33% operating margin), but if NFLX gets to the same subscription revenue figure (it did $3.6B in 2012 for reference)  and boosts its operating margin to the 15% range (from 1% now), that would imply a $1.3B EBIT potential, meaning that the company is already trading at ~9x theoretical EBIT.  There’s a lot of road to be traveled between here and there.  Those buying today should be hoping that it’s not a bumpy one.



Source: Company Filings