Netflix (NASDAQ:NFLX) recently reported its Q2 2011 earnings. Based on the several recent significant developments including the company’s push into Latin America and its emphasis on streaming, we have revised our price estimate to $221 from $150 previously. Our price estimate is around 15% below the market price and represents a marked change in our thinking. Despite our optimistic view of the company, the market is still under-appreciating competitive threats from Apple’s (NASDAQ:AAPL) iTunes, Hulu and Dish’s (NASDAQ:DISH) Blockbuster as well as video on demand offerings from pay-TV providers like Comcast (NASDAQ:CMCSA), Time Warner Cable (NYSE:TWC) and others. However we are encouraged by the growth and outlook for its streaming business, which supports our revised forecast.

In addition to the price revision, we have updated our valuation model to better reflect the contribution of international growth, which we peg at around 30% of Netflix’s overall stock value. Previously we accounted for international growth in our total subscriber estimates.

Higher Subscriber Growth Forecast

Compared to our previous estimates, we now expect Netflix to gain a larger number of subscribers over our forecast period. We expect that in the next 7-8 years, Netflix’s subscriber base in the U.S. will reach to close to 50 million subscribers. During the same time-period, we forecast its international subscriber count to reach past 20 million.

Below we highlight few points briefly as to why we think these targets may be achievable.

Although Netflix’s subscriber growth declined sequentially, we believe some of this is due to seasonality and fits a pattern that was observed last year as well. We also acknowledge Netflix’s low subscriber gain expectations for Q3 2011.^[1] However, the company is confident that growth will resume from Q4 2011, which we include in our estimates.
75% of new subscribers in Q2 2011 signed up for streaming-only plans.^[1] This not only shows the increased demand of streaming content but also demonstrates that recent price hikes for its hybrid plans may not pose much risk to its overall value since subscribers are opting for streaming-only plans.
Netflix’s Canada success has influenced our views. Although we have some reservations regarding its prospects in Latin America, we acknowledge that Netflix will take advantage of low competition in this region and expand. In addition to this, there is a possibility of expanding into other international markets such as Europe & Asia over the the next 7-8 years.
Observed shift to streaming will allow Netflix to save costs on DVDs and invest heavily in streaming content which will further fuel customer growth in the U.S. and international markets. Competition in this area hasn’t caught up yet.

We Expect a Lower Mix of DVD Related Costs Going Forward

Recent disclosures indicate that most subscribers are heading for streaming-only option. In fact Netflix stated that hybrid subscribers (DVD+streaming) declined in Q2 2011 which indicates that some of these subscribers may have shifted to streaming plans.^[1] In addition, recent price changes imply a 60% hike for hybrid customers who either leave Netflix altogether or shift to either streaming-only or DVD-only plans.

Whichever the case may be, Netflix’s DVD-related costs such as revenue sharing costs and DVD-shipment center costs will decline as a proportion of revenues. However Netflix will utilize these savings to boost streaming offerings by spending more on content acquisition.

The Q2 2011 results also implied that SG&A leverage is significant due to expansion of subscriber base and therefore this figure is expected to decline as well (as proportion of revenues).

See our complete analysis for Netflix’s stock

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