Quick Thoughts: NFLX – What a Difference a Quarter Makes


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–     NFLX bounced back from its 3Q14 drubbing to surprise in 4Q with 4.33M new subs and EPS of $0.72, both well above guidance and consensus expectations. Shares traded up 14% after hours.

–     Original programming is paying off big time. It is much more cost efficient per view than bought content and NFLX will borrow to produce more. 1Q will see the launch of key new content.

–     International expansion has been VERY successful and will hit 200 countries by the end of 2016, with material improvement in contribution. This is the primary driver of 20-25% future growth.

–     Management denies interest in PPV, live streams, and ads. These remain valuable potential levers for further monetization and value for shareholders.

Three months ago, Netflix took it on the chin after delivering fewer new subs than it had promised and were expected. While there were clear reasons for the shortfall – an unexpected price hike and a lull in the introduction of new content – 31.1% YoY growth in subs and 27% growth in revenues didn’t cut it for investors, and the stock fell 19% on the day after.

Fast forward to today. Netflix added 4.33M new subs during 4Q14, a deceleration in YoY growth from those “disappointing” 3Q14 sub numbers, but a surprise vs. the company’s more conservative guidance and consensus expectations. Sales were up 26.4%, again a modest deceleration from those awful 3Q14 numbers, but in line with expectations and EPS, at $0.72, were way above both guidance and consensus. The share price? Up 14% after hours. No wonder CEOs hate to give guidance.

Reed Hastings was in a good mood for this quarter’s webcast. Consumers have shrugged off the summer price increase, as subscriber growth held up with the strongest domestic net adds in lower income areas. A similar price increase in Mexico yielded no discernable change in the pattern of new subscribers. Perhaps Netflix has more pricing power than had been assumed as an emerging purveyor of “must see” video programming.

Netflix’s original content strategy is paying off BIG, driving new subs and drawing audiences more efficiently than licensed content on a viewers per dollar basis. The investment in shows like Arrested Development, House of Cards, and Orange is the New Black, all well received by critics and fans alike, is the cornerstone of the company’s content strategy going forward.  With its 45 Emmy nominations, 10 Golden Globe nominations and 2 Academy Award nominations, the company has gained Hollywood cred in the span of just three years. With this momentum, Netflix has committed to 320 hours of original programming to debut in 2015, a three-fold increase year on year. To underwrite the new content, Netflix disclosed it would pursue new debt offerings this year, which combined with the current low rate environment and the long shelf life of original content, are a good deal for the company.

But that’s not all, original content is also the keystone of the company’s international expansion, which was the focal point of the after-hours earnings interview. After disclosing that it reached a milestone of 5M subs in Latin America back in November, Netflix indicated that its first wave of countries were now profitable. The list includes Canada, Latin America, the UK/Ireland, and the Nordics. Reed Hastings & Company observed some originals like House of Cards carried over well across markets, with the critically panned Marco Polo doing exceptionally well in all Netflix markets. Though the aggregate contribution margin of the international streaming business ran even deeper into the red this quarter, it was due to launching service in France, Germany, Austria, Switzerland, Belgium, and Luxembourg, which took the cost of revenues up 50% QoQ.

Still, with some astute deal-making, global distribution rights for originals are now the standard and Netflix is able to reign in on costs driving its “must see” programming. This will help it scale well as it expands globally. For content producers, Netflix’s offer of global distribution solves a problem that has plagued international content rights for decades. Typically, a TV series or film would have to be shopped around to find distribution on a country by country basis. This entails added cost, time, and uncertainty. There were no true global content distributors until now. With a global deal structure, Netflix gives producers upfront cash and guarantees that are otherwise unavailable from the traditional model. It also allows for simultaneous global releases of content across markets and could potentially mitigate piracy to an extent.

Netflix is firing on all cylinders with its global launch, which it expects to be complete by the end of next year. While we see the international expansion fueling growth at Netflix well into the end of this decade, the company has left some monetization possibilities on the table. Though management has vigorously denied any interest in monetizing live programming, ad-driven content, or pay-per-view, these could be valuable levers down the line.

For our full research notes, please visit our published research site.

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