Netflix Falls After Earnings: Buying Opportunity?

Source: Netflix

What’s Going On With NetflixNetflix reported strong growth for the second quarter of 2014.

However, earnings guidance for the third quarter came in materially below expectations, as the company is planning to accelerate investments for international expansion.

The stock was falling by 5.3% on Tuesday, as investors reacted with pessimism to the news.

However, management seems to be doing the right thing by focusing on long-term growth opportunities as opposed to short-term profit margins.

Is the dip in Netflix a buying opportunity for investors?

Healthy Subscriber GrowthNetflix added 1.69 million new members during the second

quarter, an accelerated growth rate versus 1.24 million new members in the second quarter of 2013.

The company added 0.57 million subscribers in the U.S. and 1.12 million members in international markets. Both the U.S. and international markets came in above guidance.

Netflix ended the quarter with 36.24 million U.S. members and 13.8 million international members. This brings the total membership count to more than 50 million.

Management is forecasting 3.69 million new members during the third quarter.

Membership Numbers

Source: Netflix

Strong SalesNetflix produced $1.34 billion in revenue during the quarter, a

25% increase versus the same quarter in the prior year. The number was above analysts’ forecast of $1.33 billion on average.

Domestic sales increased 25% versus the same quarter in the prior year, representing approximately 73% of total streaming revenues during the quarter.

International revenue jumped by a whopping 85%, generating 27% of total streaming revenue during the period versus 20% in the second quarter of 2013.

Revenue in the DVD segment fell 16%.

Improving ProfitabilityTotal contribution margin jumped to 18.5% versus 10.2% in the

second quarter of 2013.

Contribution margin in the U.S. came in at 27.1% versus 22.5% in the prior year quarter.

Contribution loss in international markets was materially reduced, from a loss of 39.7% to a much smaller negative margin of 5%.

Management expects total contribution margin to decline to 16.6% in the third quarter due to increased spending for international growth.

Profitability Numbers

Source: Netflix

Disappointing Earnings Earnings per share came in at $1.15 during the quarter, a big

increase of 135% versus $0.49 per share in the same quarter of 2013. The number was marginally below analysts’ expectations of $0.16 on average for the quarter.

For the third quarter of 2014 management is forecasting earnings per share of $0.89, considerably below forecasts of $1.06 on average for the quarter.

Lower-than-expected guidance seems to be the main reason for disappointment among investors.

Accelerating International Expansion Management is very optimistic regarding international demand:

“What we’ve seen really is just tremendous adoption of on-demand viewing consumers around the world, whether it’s Argentina, Brazil, Finland, the U.K. -- it’s been really quite consistent.”

In September the company will be launching the service in Germany, France, Austria, Switzerland, Belgium, and Luxembourg. This will significantly expand Netflix’s total addressable market to over 180 million broadband households, or double the number of current U.S. broadband households.

International expansion is expensive, but it seems to be really worth the effort in terms of growth opportunities.

Strong Pricing Power“In May, we raised prices modestly in most of our markets for new members on our two screens at-a-time HD plan, and introduced a one screen at-a-time, standard definition plan across our markets. Our two screen HD plan continues to be the most popular plan choice for new members. We expect ARPU [Average Revenue Per User] to rise slowly as members at the new prices grow as a percentage of total membership. There was minimal impact on membership growth from this price change.”

Source: Netflix letter to shareholders, July 21, 2014.

Successful ContentThe second season of Orange Is the New Black has been the

most watched series in every Netflix territory during its first month.

Netflix original series and documentaries received 31 Emmy nominations -- more than double the 14 nominations the company received in its first year of releasing original programming.

The company is putting more focus on international markets when it comes to original productions in order to better reflect the increasingly global nature of the Netflix service.

Foolish TakeawayAccelerating international expansion will have a negative impact

on profit margins in the medium term.

However, considering how encouraging demand has been in international markets, Netflix seems to be clearly making a smart strategic move by betting on global growth.

The business is still generating impressive growth rates, both in the U.S. and abroad. Operating profitability is also moving in the right direction when leaving aside investments for growth.

Short-term weakness in Netflix may create a buying opportunity for long-term investors.

The $2.2 trillion war for your living room can be a huge opportunity for investors. Do you know how to profit from it?