Netflix and the Magical Number of Subscribers

 | Jan 31, 2013 | 1:30 PM EST
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Netflix (NFLX) has been up (at $300) and down ($50) in the last couple of years.

It's now up again after last week's earnings report. 

The big question on most traders' minds is whether it can go back to $300? I think it can.

Although Netflix's missteps that took it down from its perch were somewhat bizarre and all self-inflicted, it always had one thing going for it even in its dark days. It had a lot of subscribers.

At the time of its fall from $300, the bear case against Netflix was that:

  • It was switching from a high-margin DVD business to a low-margin streaming business.
  • Anyone can theoretically enter the streaming business, especially companies like (AMZN) with deep pockets.
  • When you have infinite competition, low barriers to entry and the possibility of that competition bidding up the content costs to a great degree, it doesn't seem like a great business.
  • Its subscriber growth was slowing.

Yet, after last week's earnings report, the stock is up big time because its subscriber growth accelerated domestically and internationally. It now has more than 30 million subscribers. Investors believe again that Netflix can keep up this momentum and shorts had to cover.

I think the thing that's made Netflix resistant to the bear arguments is that it surpassed the 20-million-subscriber level.

Why does that matter?

There just aren't that many companies out there who have been able to amass that number of subs. Check out this graph from Dan Frommer.

HBO (as of 2011) had fewer than 30 million subs. Comcast (CMCSA), Sirius (SIRI), and DirecTV had around 20 million. Tivo and Hulu Plus had around 3 million.

There aren't too many big boys above 20 million, let alone 30 million, where Netflix is now.

And Netflix is growing. HBO is likely capped along with the other pay TV and cable guys. And Hulu isn't even in the game yet.

So, now that Netflix has its mojo back, why can't these numbers keep growing? 

If you're a TV subscription provider with 40 million or 50 million subs, you are talking enormous reach power. So, even with lower margins and rising content costs, you are a player that just cannot be ignored. I think that's one reason Disney (DIS) wanted to make the move to Netflix from Starz.

And the howls from critics about Netflix needing to raise cash from a debt deal to keep itself going amidst rising content costs? It's kind of like Amazon. It is building enormous power in its sub base. It's not that the costs don't matter. It's just that you have to project those costs over the value of say a 50- or 60-million subscriber base.



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