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Hidden Gem in the Netflix Cashflow by Jordan at Investing Blog

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Netflix is one of the few companies that can get a pass for missing earnings expectations. The company posted 3Q earnings of 70 cents per share, an annual increase of 26% and a penny below estimates. But analysts didn’t really care about the missed expectations, instead, investors sent the company higher to $167, up exactly $18 on the extended trading day.

Netflix Business Model

Much of Netflix’s business mode relies on aggregating contracts and then dividing the expense among millions of subscribers. The company has no true science to negotiating content acquisition deals and admits some content costs several times more than other content. At the end of the day, Netflix’s job is to grow its catalog while keeping total cash outflow lower than its inflows.

In the third-quarter, Neflix’s subscriber base grew to a whopping 16.9 million active subscribers and was above the best case trend set forth by the company at the time of the last earnings call by a difference of 200,000 thousand active customers.

More customers help to spread around greater acquisition costs. Netflix spent 10% more in 3Q 2010 on content acquisition than it spent in the same period 1 year ago.

More to the Story

There is more to the story than the simple addition of new customers and a growing library. Analysts are now wondering when Netflix will cut off its physical DVD delivery in exchange for a streaming only library. Such a move could save the company up to $800 million annually.

Keep in mind, in all of 2009, Netflix brought down only $115 million. By erasing its postal costs, Netflix profits could surge nearly 700% overnight, adding significantly to the bottom line and justifying its exceptionally high price-to-earnings ratio.

I think this is an interesting stock and an interesting business model. If the company can kill the DVD business without negatively affecting revenue, I’d buy this company hand over fist. Minus the mailing operation, this is a company that requires very little capital investment or manpower. It’s just a website with a few hundred high-powered content deals, all spread over millions of subscribers. I love it, but I hate its current multiple.

About Jordan

Jordan is the web master of www.investingblog.org, a site dedicated to skillful investing, news and recent trends. You can read the original article here.

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