How Netflix Will Get to 90 Million U.S. Subscribers

Image Source: Netflix.

More than 47 million Americans subscribe to Netflix (NASDAQ: NFLX), but CEO Reed Hastings thinks that number could nearly double before it saturates the market. In the company's long-term view, it states that it expects to "grow to 60-90 million members in the U.S., based upon our trajectory to date and the continued growth of Internet TV."

But it might not be the "growth of Internet TV" that drives subscribers as much as a decline in viewers using someone else's account. I'm not talking about nefarious password sharers. Rather, there's a huge number of young people who watch Netflix, but use their parents' accounts. Analyst Ralph Schackart at William Blair estimates that about 36.4 million Netflix watchers between the ages of 10 and 24 are not paying for a subscription.

As that viewer base ages, they're expected to start paying for their own subscriptions, which provides an additional avenue for subscriber growth for Netflix.

How many of those viewers can Netflix convert?

It's practically impossible that Netflix will convert all 36 million of those viewers in any reasonable amount of time (five years). But as those viewers move out of their parents' homes and start lives of their own, Schackart expects at least some of them to start paying.

Based on survey data regarding willingness to pay among different age groups, M. Schackart believes Netflix can convert 3% of that audience into paid subscribers annually. That's more than 1 million additional subscribers every year if Schackart's correct. For reference, Netflix added 4.8 million subscribers over the last year, and it expects subscriber growth to slow down significantly this year.

Still, that's only going to account for 5.3 million in new subscribers over the next five years. And it's a lot harder to convert customers, who are used to getting something for free, into paid subscribers (although Schackart appears to be very conservative with his estimate).

Keep in mind, cable industry analysts expected similar behavior from millennials as they established their own households to fuel growth in pay-TV subscribers. Despite an uptick in household formation over the last couple of years, the total number of pay-TV subscribers continues to decline. It may be that those people are subscribing to over-the-top services like Netflix, or they may continue to mooch off their parents' Netflix passwords.

But where will the other 40 million come from?

Netflix is taking a very balanced approach with the U.S. market right now. It needs the contribution profit from its domestic operations to fuel its international expansion, while also supporting its massive content spend. As a result, it expects "there may be quarters where net adds are down year over year, which is the natural result of greater penetration," according to its investor FAQ.

So, when Netflix says "long term," it means very long term -- like "eventually."

But even older premium television networks -- which is essentially what Netflix has become -- have had trouble penetrating the market even as much as Netflix has. Time Warner's (NYSE: TWX) HBO, for example, has around 36 million subscribers in the United States. And HBO has been doing what Netflix is doing for much longer. Still, Time Warner CEO Jeff Bewkes believes HBO will also reach 50 million to 70 million households in the United States.

The growing trend in quality over quantity in television programming favors networks like Netflix and HBO, which are offered a la carte to consumers. And Netflix's original programming is considered some of the highest quality among viewers. A recent survey from Morgan Stanley found that more Americans love Netflix originals more than HBO's.The growth in Netflix's original programming and the improvement in its quality ought to support further organic subscriber growth in the United States through a reduction in churn and gross additions.

The secular growth in broadband households and use of over-the-top streaming services will continue to benefit Netflix, and its original content will help it maintain its position as a market leader in streaming video on-demand services. Mr. Schackart believes that will add more than 12 million subscribers on top of the 5 million additional conversions from young people. That would bring Netflix's total U.S. subscriber count to more than 64 million.

Over the next 10 years, Netflix could add another 25 million subscribers to reach around 90 million by 2030. Those 10-year olds in Mr. Shackart's survey will be 24 or 25 by then when they're about 60% more likely to pay for Netflix.

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Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Netflix and Time Warner. 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.