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Cable Technology Feature Article

August 08, 2014

Netflix Passes HBO in Revenue, But There's Still Work to Do

By Tara Seals, TMCnet Contributor

Netflix CEO Reed Hastings quietly made an announcement this week, via his Facebook page:

“Minor milestone: last quarter we passed HBO is subscriber revenue ($1.146B vs $1.141B). They still kick our ass in profits and Emmy's, but we are making progress. HBO rocks, and we are honored to be in the same league. (yes, I loved Silicon Valley and yes it hit a little close to home.)”

It’s no surprise the revenue growth is there: Yahoo! Finance said that Netflix has grown revenue by about 20 percent annually for the past two years. For 2015, analysts expect revenue growth of 21.8 percent over 2014. 

But despite the low-key delivery, the news is critical for the company as it struggles to find domestic growth and maintain margins. Because HBO—Netflix’ stated arch-rival—is indeed “kicking ass” in profits: the premium cable net raked in $1.8 billion in operating profit last year, which is about a quarter of parent Time Warner (News - Alert)'s $4.9 billion annual revenue. For the fourth quarter, it reported $413 million in income. In contrast, Netflix profit for Q4 came in at $48 million.

That means that HBO essentially has deeper pockets for commissioning more original content, which more and more is the differentiation point for premium services.

Jason Russ, an analyst at Seeking Alpha, said that he believes Netflix will have to work to keep its gross margin over 30 percent going forward amid international expansion efforts and escalating operational costs.

“In itself, there is nothing worrisome about a high-growth company spending cash,” he said. “But it is telling that Netflix has had to spend much more in the last few years in order to promote continued growth. New content, ventures in Europe and delivery costs are eating up cash much faster now than when Netflix was picking that low-hanging fruit.”

Meanwhile, Netflix has been facing increased content costs as it strives to find differentiation with original series and exclusive licensing deals. While the number of streamers will continue to grow, there is a limit to how many services the average viewer will pay for — and Netflix wants to be one of those.

And, there’s the paid peering trend to consider: Netflix has paid Comcast, Time Warner Cable, Verizon (News - Alert) and AT&T for a direct interconnection with its CDN, so that end users have a solid quality of experience.

And meanwhile, when it comes to revenue growth, it hasn’t kept up with costs — nor is it likely to any time soon given that Netflix has hit a saturation level in its domestic market of the United States.

“I believe Netflix will see its market share start to erode at some point,” Russ said. “Furthermore, even if Netflix does somehow keep market share high for the foreseeable future, we can see from the cash flow and gross margin trends that it is working harder than in the past to get new subscribers.”

Overall, Netflix continues to grow and make healthy profits. But, the revenue growth from now on will come at a higher cash and margin cost than it did in the past.

“20 percent top-line growth is still very good, of course…I certainly don't expect the margins of Netflix to drop dangerously,” Russ said. “But it does seem like the halcyon days of 2006-2011 (approximately 35 percent gross margin) are gone for good.”

Edited by Maurice Nagle

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