Netflix Surges on Higher Viewership

Shares of Netflix Inc. ( NFLX - Analyst Report ) surged 13.4% to close at $81.72 on July 5, 2012, after Chief Executive Officer (“CEO”) Mr. Reed Hastings recently announced that subscribers watched 1 billion hours of television shows and movies in the month of June.

In his blog post on social networking site Facebook ( FB - Analyst Report ) , Mr. Hastings shared his optimism on the upcoming releases of House of Cards and Arrested Development, which are believed to drive further viewership.

Netflix is expected to stream House of Cards, starring Kevin Spacey, later this year. The company plans to air 10 new episodes of Arrested Development in early 2013. This show will also be available to United Kingdom and Ireland subscribers.

The recent surge in viewership has been primarily driven by Netflix’s engaging content, in our view. Lately, Netflix has made a name for itself by offering new and exclusive content to its subscribers compared to the traditional content provided by some of its closest peers.

Netflix continues to offer new content through partnerships with leading Hollywood studios and entertainment companies such as Metro-Goldwyn-Mayer, Twentieth Century Fox, Hasbro studios, The Weinstein Company (TWC), Warner Bros. Domestic Television Distribution, Epix to name a few.

Apart from House of Cards and Arrested Development, Netflix has also acquired the rights of another couple of original series, namely Orange Is the New Black and Gaumont International Television production Hemlock Grove. Netflix is expected to stream five original series by 2013 end.

We believe that the improved content makes its streaming services distinguishable from other service providers as HBO, Amazon.com Inc. ( AMZN - Analyst Report ) , Hulu as well as the newly launched services from cable and media companies such as Comcast Corp. ( CMCSA - Analyst Report ) , Dish Network Corp. ( DISH - Analyst Report ) and Verizon Communications ( VZ - Analyst Report ) .

Netflix’s library not only contains varied types of documentaries and movies but also original television shows of different genres. This is reflected from the fact thatHouse of Cards is a political thriller; Arrested Development is a comedy, Orange Is the New Black an autobiography, while Hemlock Grove is Netflix’s first venture into original horror series.

We believe that this variety in content will help the company to further boost customer engagement going forward. At the end of 2011, Netflix was among the worst performers with respect to customer satisfaction among the largest online retailers. This was a significant drop considering the fact that the company was the joint leader in 2010 holiday season and has been one of the top-performers historically.

Recently, Netflix said that it is considering a plan to redesign its website that will separate movie viewing options from its growing television catalog, in order to make it easier for subscribers to find programs of their choice going forward. However, the company is yet to confirm the redesign.

Our Take

We believe that Netflix will continue to pursue different avenues and ventures in order to expand its online subscriber base going forward. Netflix’s future growth strategy is entirely based on the online streaming business, as its DVD rental business continues to witness subscriber losses.

We believe that Netflix’s improving content portfolio and international expansion are noteworthy. Despite higher license renewing costs, we think Netflix will probably see sales strengthening, as subscribers take note of the improving portfolio. This would ultimately enable the company to strengthen its position over the long term.

However, unless that happens we prefer to remain on the sidelines. We also believe that higher capital expenditure due to international expansion will hurt earnings growth in the near term. We are Neutral on the stock over the long term (6-12 months).

Currently, Netflix has a Zacks #3 Rank, which implies a Hold rating over the short term.