Netflix Inc. Stock: A Horror Story for Short-Sellers

By Markets Fool.com

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Source: Motley Fool.

Depending on your point of view, Netflix stock can be seen as either an amazing action story or a heartbreaking drama. The bulls are clearly feeling like they are living in a fairy tale, Netflix is up by more 950% over the last three years, trading near historical highs in the neighborhood of $662 per share. The short-sellers, on the other hand, are enduring plenty of pain, losing tons of money as Netflix stock continues defying gravity.

Netflix has always been among the most shorted stocks in the market; even after such an explosive run, it still carries a relatively high short interest ratio of nearly 6.5% of the float, so the shorts have not given up by any means. Is a short position in Netflix a suicidal bet or will patience and conviction pay off for the bears?

How Netflix is crushing the bears
One of the biggest victories for the bulls over the last few years is that Netflix has proven it has the competitive strength to grow and thrive despite rising competitive pressure in the online streaming space.

Amazon.com has traditionally been considered a major competitive threat for Netflix, and Time Warner's HBO recently entered the space with its new HBO Now streaming service.

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Nonetheless, Netflix ended the first quarter of 2015 with 62.3 million streaming members, an increase of 4.9 million new members from the same quarter in 2014. Three years ago, in the first quarter of 2012, the company had only 26 million streaming members globally. Subscribers watched an amazing 10 billion hours of content during the last quarter, so engagement is at record levels, too.

BTIG Research calculated that the average Netflix subscriber streams nearly two hours of movies and program per day. This would mean Netflix is not only the undisputed leader in online streaming, but also rivals the leading U.S. networks when considering both online and linear TV.

Content is king in the industry, and Netflix's bet on original content is paying off in spades. Major blockbusters such as House of Cards and Orange Is the New Black generate significant viewership for a convenient cost, and they also differentiate the service from the competition, providing a key competitive advantage for Netflix.

What the future may bring
Netflix's strategy over the coming years can be defined as a tale of two very different markets: growth in the U.S. will probably slow as this market matures, but profit margins should rise. In international markets, the company will invest tons of money for growth, so costs will weigh on profitability, but foreign revenue should grow rapidly for years to come.

Netflix has 41.4 million members in the U.S., an increase of 4.88 million new members during the last quarter.This growth rate is actually an acceleration from 4 million new U.S. members in the first quarter of 2014, but it makes sense to assume that a bigger subscriber base will naturally mean slowing growth, at least in percentage terms, in coming years.

On the other hand, contribution margin in the U.S. has grown from 25.2% in the first quarter of last year to 31.7% in the latest earnings report. Management believes the business is well on track to producing a contribution margin in the area of 40% in the U.S. by 2020.

International markets should remain powerful growth drivers over the next couple years. Netflix plans to expand from its present 50 markets to 200 countries by 2017. Increased marketing and operating costs, as well as more original productions targeted toward global markets, will probably mean rising costs abroad. However, Netflix's track record in the U.S. shows the company understands how to balance growth and profitability over time.

When looking at the main business model dynamics on a global scale, it's important to keep in mind that a growing library of valuable exclusive content should mean increasing pricing power for Netflix going forward. Considering that clients are used to paying considerably more for traditional pay TV than for online streaming, Netflix has a lot of room to raise prices and profit margins as long as it continues delivering the right content to subscribers.

The Netflix growth story is far from over. After such an impressive run, and trading at aggressive valuation levels, the stock is certainly vulnerable to any disappointment in the short term. However, from a long-term point of view, the company looks well positioned to expand both sales and profits over years to come.

Betting against Netflix stock has been a very expensive mistake over the last few years, and I see no reason why this should change anytime soon.

The article Netflix Inc. Stock: A Horror Story for Short-Sellers originally appeared on Fool.com.

Andrs Cardenal owns shares of Amazon.com and Netflix. The Motley Fool recommends Amazon.com and Netflix. The Motley Fool owns shares of Amazon.com and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.