- Netflix earnings Q3 2015 were announced on Oct 14, after market close. The company slightly missed on both top and bottom line expectations.
- Netflix shares sold off wildly at first before staging a recovery.
- Netflix's domestic subscriber growth is likely to come under some pressure in the fourth quarter due to loss of original content.
- The long-term outlook for the shares, however, remains bright.
Streaming video giant Netflix (NASDAQ:NFLX) reported Q3 FY 15 earnings that missed on both top and bottom line expectations, sending its shares tanking wildly. Netflix reported revenue of $1.74 billion and EPS of $0.07 both of which missed consensus estimates of $1.75 billion for revenue and $0.08 EPS. However, as usual, subscribers were watching hawk-eyed for the one number that matters most to them: subscriber growth. Netflix’s subscriber growth was a mixed bag: the company reported that it had added 0.88 million new domestic subscribers, below expectations of 1.15 million. The company, however, reported better-than-expected international subscriber growth--2.74 million vs. 2.4 million consensus. This in effect means that Netflix finished the quarter with 50,000 net subscribers more than consensus estimates. CEO Reed Hastings succinctly explained that the lower domestic subscriber number had been caused by ‘‘involuntary churn.’’ Involuntary churn really is the inability of subscribers to connect to Netflix due to the ongoing transition to chip-based credit and debit cards.
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But investors were nonplussed and took the lower-than-expected domestic subscriber numbers and missed earnings to mean that growth at Netflix had hit a speed bump. Netflix shares sold off heavily and were down as much as 14% at one point, before paring back their losses and staging an almost full recovery. Netflix shares ended the trading session just a couple of points off. The huge swing can be taken to mean that investors took time to digest the results and decided that the company’s growth numbers were quite decent after all.
Streaming revenue down, margins up
Despite the overall better-than-expected subscriber growth numbers, Netflix’s streaming revenue of $1,581 million came in slightly below estimates of $1,593 million. This can be attributed to FX headwinds due to Netflix’s growing exposure to international markets.
Netflix’s profit margin of 17.5% was, however, 40 basis points better than estimates. This can be chalked up to the company’s increase in monthly subscription fees in international markets such as the UK. Netflix increased the monthly subscription fee in the UK from £5.99 to £6.99, which is significantly higher both in absolute and relative terms compared to the company’s recent $1 increase in the US, Canada, and parts of Latin America. Netflix is likely to see another margin uptick after the latest price increase begins to be implemented after the grace period of a few months expires.
International markets to drive future growth
It’s beginning to increasingly appear as if Netflix investors will have to get used to the idea of most of the company’s growth coming from international markets. Netflix finished the quarter with 43.2 million domestic subscribers and 25.99 million international subscribers. This in effect means that roughly only 37% of Netflix revenue is coming from international markets. Netflix still has plenty of room to run before it can match the roughly 65%-80% of overall revenue that the average Internet company gets from its international markets.
Netflix entered nine international markets over the past 12 months. Judging by the company’s comments about raising more cash through corporate debt auctions, it’s fair to say that Netflix has no plans on slamming the brakes on its international expansion drive, and is in fact likely to accelerate it going forward.
But judging by the healthy international growth, I don’t expect the company’s international expansion costs to eat into profits too much. In fact I expect the incremental revenues from these markets to offset development costs on an ongoing basis.
Short-term content headwinds
As expected, Mr. Hastings did talk about Netflix’s content challenges and growing competition. The biggest problem facing the company right now is the lack of original content after its 5-year deal with Epix ended in September. I expect that Netflix’s domestic subscriber growth will be impacted to a certain degree in the fourth quarter by the lack of original content during the hot holiday season. Netflix Stock is priced for perfection and high growth a la Amazon. As was aptly demonstrated during the latest Netflix earnings call, Netflix investors do not take slowing subscriber growth lightly. I would therefore like to reiterate my earlier call to take some profits heading into the first quarter. Over the long-term, however, Netflix has clear growth paths which should provide strong upside potential to the shares even at the current apparent overvaluation.