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Is the Netflix Stock Boom a House of Cards?

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The company had a strong first quarter, but questions about the sustainability of its model remain.

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Earlier this month, BTIG Research analyst Richard Greenfield crunched some numbers and found that if Netflix (NASDAQ:NFLX) were a cable TV network, it would probably be the highest rated one.

"We believe Netflix streaming per sub/day is now over 87 [minutes, compared with 79 minutes last summer] and, in turn, Netflix is now likely the most watched cable network, essentially in-line with the Disney (NYSE:DIS) Channel," calculated Greenfield on the BTIG blog (registration required).

The popularity of Netflix over cable networks was confirmed yesterday when the Los Gatos, California-based company reported quarterly earnings.

According to its report, Netflix added over 2 million new US streaming subscribers (3 million worldwide) in the first quarter, bringing its total domestic subscriber count to 29.17 million.

That means that Netflix has officially surpassed HBO (NYSE:TWX) in domestic subscribers for the first time ever, Variety points out. Based on data from SNL Kagan, HBO had 28.7 million subscribers at the end of 2012.

Of course, HBO is still far and away the top dog globally, with some 114 million subscribers worldwide, while Netflix's total subscriber population stands at 36 million.

HBO also still has the edge in terms of paid subscribers. At the end of March, Netflix's paid streaming subscriber count was 27.91 million, with the remaining customers signed on for the company's free monthly trial.

Thanks to its stronger-than-expected subscriber growth – which means an improved contributing margin since content costs are spread over more customers – investors were impressed with Netflix's first quarter, sending shares up 24% to above $200 in after-hours trading on Monday. The stock is up some 90% so far in 2013.

Most analysts attribute Netflix's strong subscriber growth to its focus on exclusive content, which the company hopes will differentiate it from competitors like Amazon (NASDAQ:AMZN) Studios, Coinstar (NASDAQ:CSTR) and Verizon's (NYSE:VZ) Redbox Instant, and Apple's (NASDAQ:AAPL) iTunes. In the first quarter, Netflix debuted its high-profile and expensive original series, House of Cards, to great reviews.

"What we've seen with House of Cards is a nice impact but a gentle impact," said Netflix CEO Reed Hastings in a conference call Monday evening.

Because of the company's heavy investment in original content (the two planned seasons of House of Cards will cost $100 million) and rising non-original content acquisition costs, Netflix actually reported negative free cash flow of $42 million in the quarter (though that was an improvement from negative $51 million in the previous quarter).

In other words, Netflix is following the Amazon model: It's bleeding cash as it attempts to dramatically scale up, but the stock continues to rise anyway.

Once Netflix has reached subscriber saturation, the company will have to start making money, either by reducing content costs (which isn't likely, given that Amazon and other rivals will big fiercely for content), or by raising revenue. The question, then, is whether customers will accept a subscription fee that is higher than $7.99/month. We'll find out soon as Netflix says it plans to introduce a new $11.99/month plan that allows simultaneous streaming on four devices.

See also:

Who Isn't Producing Original Content These Days? Redbox Instant and Microsoft Latest to Enter Fray

Apple's Implied Volatility: Long and Wrong?

Why You Might Be Sharing a Cubicle With Your Windows Phone

Twitter: @sterlingwong
No positions in stocks mentioned.
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