- Netflix reported mixed Q1 2016 results.
- The stock has sold off badly after the company provided light subscriber growth guidance.
- The profit narrative, however, remains intact and could drive long-term gains for the stock.
Netflix (NASDAQ:NFLX) stock has been badly hammered after the company reported mixed first-quarter results and forecast lower-than-expected subscriber growth for the second quarter. Netflix reported Q1 2016 revenue of $1.96B, good for 24.8% Y/Y growth but $10M lower than Wall Street consensus. EPS of $0.06 was 20% higher than a year ago and $0.03 better than analysts' consensus. Netflix reported that it had added 2.23M net subscribers in the U.S. and another 4.51M net subs in international markets thus exceeding its projections for 1.75M and 4.35M for domestic and international markets, respectively. Netflix finished the quarter with 81.50M subscribers to top its own guidance for 80.86M.
Total streaming contribution margin was up 80bp Q/Q to 17%. Streaming contribution margin in the U.S. reached 35.5% while the same metric in international markets narrowed down to -16.0% from -19.2% during the fourth quarter.
It was Netflix's forecast for second-quarter subscriber growth that did the damage and sent the shares tumbling. The company said that it expects to add just 500M net subs in the U.S. during the quarter and 2M in international markets, well below the 4M+ that many analysts had projected for international markets. Netflix's guidance for half a million net subscriber adds in the U.S. market actually surprised on the upside considering that many analysts had lower projections owing to expected price increases during the year. Netflix decided to stagger the increases throughout the year instead of implementing them in one full swoop.
The expected weak growth in global markets has been pinned on a weaker catalog of content in these markets compared to the domestic market. Although Netflix can be viewed in more than 190 countries around the world, the company needs to do much more on the content side to bring it on par with standards in the United States. Domestic subscribers have more than 5,600 titles to choose from compared to less than 700 in less privileged territories. The lack of sufficient content in international markets has not been helped by Netflix's recent move to block subscribers from using software that hides their VPN so as to access U.S. content.
Amazon A Threat?
Netflix's lower than expected growth could not have come at a worse time after Amazon (NASDAQ:AMZN) recently launched a standalone video service. At $8.99/month, Amazon's video service is a dollar cheaper than Netflix's standard plan. The standalone video service will not be bundled with Amazon Prime, as had been the case previously, thus allowing it to compete more directly with Netflix. Although Netflix offers a basic plan for $7.99/month, the service does not include access to high-definition video content which Amazon's new service will include. The service will offer 4K content compared to Ultra HD programming which Netflix offers through a $11.99/month Premium Plan.
Earnings Growth Could Drive Netflix Stock
Netflix is certainly not going to have an easy time growing in international markets as it did in the U.S. Each market has its own unique challenges and a one-size-fits-all model is unlikely to work. Further, Netflix's streaming margins outside the U.S. remain deeply in the red though losses have been coming down. Meanwhile, new challenges are continuously emerging. Although Netflix mostly downplayed the new Amazon video service, its threat cannot be underestimated. Netflix says that its main gambit remains its huge lead in original content, a sentiment that seems to be supported by a recent Morgan Stanley survey.
Netflix expects to spend $6B on new content in 2016 up from $5B in 2015, implying 20% Y/Y growth. Growth in content costs is, therefore, likely to come in lower than top line growth thus allowing more dollars to trickle down to the bottom line. Indeed, Netflix has said that it expects to post material global profits starting 2017:
Source: Wall Street Journal
While much investor attention will continue to be focused on Netflix's subscriber growth, solid profitability could ultimately change the long-term fortunes for the stock.