Netflix earnings jump as it surpasses HBO in U.S. subscribers

Netflix Inc. surpassed rival HBO in domestic subscribers in the third quarter, a milestone it credits to buzz surrounding original series such as “Orange Is the New Black,” the Emmy nominations for the political drama “House of Cards” and other exclusive content.

The online movie and television subscription service borrowed a page from the cable network in launching high-profile original series, such as the drama that garnered “House of Cards” director David Fincher a prime-time Emmy award, to redefine its brand and attract subscribers.

The programming strategy appears to be paying off. Netflix reached 31 million subscribers in the U.S., compared with 29 million domestic subscribers for HBO, according to SNL Kagan.

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Netflix Chief Executive Reed Hastings acknowledged that it may take several years before the service catches HBO when it comes to worldwide reach. Netflix has more than 40 million worldwide subscribers, up from less than 30 million a year earlier. HBO, by comparison, had 117 million subscribers worldwide at the end of 2012, according to parent Time Warner Inc.’s financial filings.

“As we grow, HBO is focusing on doing their incredible work … expanding more aggressively internationally,” Hastings said. “We hopefully grow a lot. I don’t know when we catch them.”

The subscriber growth helped fuel Netflix’s third-quarter net income, which reached $32 million, or 52 cents a share, for the three months ended Sept. 30. That’s four times its earnings of $8 million, or 13 cents, in the same quarter last year.

Revenue reached $1.1 billion, up 22% from the same period in 2012.

Investors reacted enthusiastically to the results. Netflix shares, which closed Monday up $21.49, or 6.4%, at $354.99, rose nearly 11% in after-hours trading to $393. The stock is up nearly 300% this year.

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Hastings took the unusual step of commenting on what he termed “investor euphoria,” which has driven Netflix’s stock to record levels this year. He said the investor enthusiasm is reminiscent of 2003, when the Los Gatos, Calif., company was the highest performing stock traded on Nasdaq. He wrote that Netflix will focus on growing its subscriber base, doing its best to ignore the stock’s volatility.

“There’s not a lot we can do about it,” Hastings said on a Google hangout Monday with investors.

Wedbush Securities analyst Michael Pachter said investors appear to be overlooking the poor return on revenue as Netflix invests heavily in content.

“They don’t generate very much cash,” Pachter said. “It’s right on the first page of their letter [to investors]. They’re getting rewarded with $1 billion in revenue, and they do $7 million in free cash flow.”

Hastings said Netflix needs to continue to add about 6 million subscribers a year to grow profit margins and continue investing in programming.

He described the “twin engines” propelling the company as content — original shows, as well as exclusive access to past episodes of such popular TV shows as Fox’s “New Girl” or AMC’s “Breaking Bad” — and technology enhancements. These include the recently introduced profiles feature, which enables parents and children to create separate identities on the service and receive recommendations appropriate to each individual.

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Spending on original programming is likely to double in the coming years, Chief Financial Officer David Wells said. Netflix currently allocates about 10% of its global content budget on original programs.

Chief Content Officer Ted Sarandos said that investment represents second seasons of existing shows, including “House of Cards,” “Lilyhammer” and “Orange Is the New Black,” as well as deals that have yet to be announced. He said he expects “Sense8,” the new series from “The Matrix” co-directors Andy and Lana Wachowski, to arrive in late 2014.

“Remember, we’re kind of trying to optimize for high-quality shows,” Sarandos said. “They take a long time to deliver.”

Sarandos said Netflix is also weighing its entry into films, trying to determine how it can break new ground — much as it shook up the television industry by releasing all the episodes of its original TV series “House of Cards” at once, to give subscribers greater choice in viewing.

“We are actively looking at a few documentary projects that would premiere on Netflix,” Sarandos said. “On the movies side, I would like to keep my mind wide open as to what those films would be and what they would look like.”

Sarandos said Netflix wouldn’t court licensing deals with professional sports leagues such as the NFL, which has reportedly been in talks with digital distributors.

“We’re not interested in sports,” Sarandos said, noting that the service’s key attribute is offering entertainment on demand. “I don’t think that brings much to sports viewing, which is primarily a linear experience.”

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