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Is Netflix, Inc. (NFLX)’s Growth Built on A House of Cards?

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Netflix, Inc. (NASDAQ:NFLX) came up with a new form of TV programming as it released the highly anticipated show named “House of Cards.” All thirteen episodes of this show became available directly on Netflix’s website. If this show will be profitable, it could mark another shift in content business. This series’ name brings to mind the recent spike in Netflix’s stock. Was it based on a fundamental improvement? Is the company’s business model of pay-per-content sustainable over advertising?

Since the beginning of the year, shares of Netflix soared by nearly 92%. This rally led the company’s P/E to spike to 614. This sharp rise was explained by analysts to be related to two main factors: 1. the much better than anticipated fourth quarter earnings report of the company; 2. the speculation that Netflix will take the place of Dell in the Nasdaq-100 index. These reasons might have some merit to pull up the company’s stock but is this spike in the stock price demonstrates an irrational exuberance behavior by investors and traders?

Netflix, Inc. (NASDAQ:NFLX)The company’s revenues grew by nearly 8% in the last quarter and by 12.6% during 2012. These numbers, stand alone, aren’t staggering and are well below the growth in revenues of other leading companies that provide, among other services and products, paid content. Apple Inc. (NASDAQ:AAPL) is another player in the paid content industry with its iTunes service that reached revenues of $3,687 million in the first quarter of the fiscal year of 2013. This represented a growth in revenues of 22%. This means, Apple’s growth in its content related sales was much higher than the growth in revenues of Netflix in the last quarter. Therefore, if you believe the direction of paid content is sustainable, then Apple is showing much more promise in terms of growth than Netflix does.

The second issue worth considering is the very low profit margin of Netflix. The profit margins on paid content (e.g. music, books, movies etc.) aren’t likely to be high. During 2012, the operating profitability of Netflix declined to 1%. In comparison, in 2011 the profitability of the company was 12%. Other companies that sell content such as, Inc. (NASDAQ:AMZN) also have low profitability that continues to fall: in 2012 the operating profitability of the company was 1.1%. In 2011, it was 1.8%. But the revenues growth of Amazon was much higher than Netflix’s at 27% in 2012. If the profitability of Netflix will remain around the 1% to 2% range, which is the same range as Amazon, perhaps it’s worth considering Amazon that has a much higher growth rate than Netflix and its basic business model is in the same neighborhood.

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