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Netflix Q3 2018 Takeaways: The Underlying Kingpin in the Global Media Landscape

Professor of Financial Economics and Part-time Value Investor, Transfin.
Oct 18, 2018 7:28 AM 4 min read
Editorial

Netflix reported Q3/18 results on Tuesday after market close. Given that the stock tanked close to 12% over the last 5 days ahead of the earnings, albeit part of larger tech-led sell off, it is perhaps worthwhile to have a quick look at the quarterly print. The purpose of this post is not to get into nuances of stock price movements or highlight trading strategies but to provide some colour on one of Wall Street's favourite narratives whilst also searching for read-through's on the global media landscape within which, Netflix is undeniably the underlying kingpin. 

 

[Listen in from the beginning to learn more on Netflix's Q3 results]

 

Robust all-round subscriber loading and strong guidance were key Q3 takeaways; stock up 12% after-market and a further 5%+ on Wednesday. Netflix added 7m subscribers globally in the quarter, which were ahead of company's internal forecast of 5m and also ahead of Wall St consensus estimate of 5.2m. 

The variance relative to forecast was largely due to greater-than-expected subscriber acquisitions globally, with strong growth broadly across all markets including Asia. Netflix added 5.9m subscribers in the international circuit and 1.1m in US. The total subscriber count now stands at a lofty 137.1m (78.6m global and 58.5m US). A stunning run, considering the modest c.30m subscriber count in 2012! Netflix's internal Q4/18 forecasts of 9.4m net new subscribers, appears to be ahead of prior estimates as well. While there are many moving pieces that drive the stock price, in Netflix's case, subscriber numbers are perhaps most closely watched and as such have significant sway in moving the stock. In that context, the results were received positively by investors as evidenced by the 12% stock price surge in after-market hours before a further 5%+ uptick on Wednesday. 

 

India strategy was a key talking point in the earnings interview; Netflix sees meaningful growth runway within the Indian marketplace at current price-points as well. 

The earnings interview saw meaningful air-time on India specific questions. Management appeared to be confident on a long growth runway at current price points in India but rather bluntly stayed clear on giving out any subscriber count in India for "competitive reasons". India is increasingly viewed as a meaningful growth lever for Netflix and management commented on the success from its recent programming - Lover per Square Foot and more high-profile series' Sacred Games and Ghoul . The prospect of evolving from English towards more vernacular programming appears to be a key focus area alongside other India-specific pricing and bundling strategies. In that context, Netflix's partnerships with Airtel, Hathway Broadband, Tata Sky etc can perhaps be viewed as guideposts on how it aims to drive growth beyond the already well-acquainted target base in India. 

 

Free cash flow expected to be negative for years to come and the narrative is generally in-line with expectations. Management expects a free cash flow burn of -$3b to -$4b in 2018 and expects to be within the same range in 2019 as well.

Management reiterated their belief of staying free-cash flow negative for years in future by underlining the need of investments (the biggest free cash flow drag) in order to drive growth in revenue and operating profit. It expects to spend a lofty $8b in content investments in 2018 dwarfing the spend profiles of close competitors in the space. Netflix's lack of free cash flow generation is somewhat of a contentious topic for investors. Investors appear to have question marks on when these lofty levels of content investments will begin to ease in order to turn free cash flow positive. However, management focus appears to be unshaken, perhaps supported by the thesis that the rate of resulting growth in operating profit will outpace the rate of growth in content investments over the longer term.

 

'Product partnerships' appear to be taking heightened focus to extract growth from niche pockets as evidenced by additional traction on bundling with mobile carriers.  

As per management commentary, Netflix has rolled out their first mobile bundle in Japan with KDDI and also expanded on existing partnership with Verizon to pre-install the Netflix app on Android phones. The strategy as such appears to be directed towards bundling with mobile carriers to gauge easier app discovery and in turn gain traction towards driving subscriber growth and retention. Even from an Indian perspective, we have seen Netflix make strategic partnerships with Airtel, Hathway Broadband, Tata Sky among others with the same underlying logic of helping easier and seamless discovery of Netflix to extract growth in pockets beyond the tech savvy 'early adopters'. This appears to be part of the general optimizing growth strategy to exploit the tailwinds in the current market. As a side-note, in the interview, Netflix CEO, Reed Hastings indicated that they have a long growth runway in current market (5-10 years) and the focus is towards optimizing and strengthening the current market and strategy rather than the need to diversify to maintain growth. 

 

Interest rate hikes and other macro headwinds aside, Netflix's Q3 serves as an endorsement of underlying fundamentals to facilitate stock price movements. 

Ahead of the Q3 earnings print, Netflix had seen its shares drop close to 12% over the past five days, albeit part of a much broader sell-off led by tech stocks. While the fundamental metrics helped the stock in recovering its macro-led losses, the risks of rising rates and other macro factors are meaningful headwinds that could pressure the stock. In that context, Q3 solid quarterly results bode well for Netflix and offer a nice reminder on company 'fundamentals' in an environment where rising rates and narrowing treasury bond yield spread has grabbed much headlines and somewhat dictated stock price movements.  

 

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