Netflix Earnings Preview: Eye on Subscriber Numbers As Netflix Looks To Get Back On Track

Netflix (NASDAQ:NFLX) will release its Q4 2014 earnings on January 20^th and the results will be under intense scrutiny given the disappointing Q3 numbers posted by the company. We expect that the overall customer base will continue to grow but the rate of growth is likely to come down compared to last year as the market slowly moves towards the point of saturation. Netflix’s content superiority and device reach have been the primary drivers behind its success, and that’s unlikely to change anytime soon, as the company continues to invest in original and exclusive content. Our price estimate for Netflix stands at $299, implying a discount of about 11% to the market.

See our complete analysis for Netflix

Solid But Unspectacular Domestic Subscriber Growth

We expect Netflix to meet its guidance and add around 1.85 million new subscribers to its existing subscriber base for the quarter. ^[1] The company missed its guidance for the last quarter and added a little less than 1 million subscribers domestically, as opposed to its earlier expectation of 1.33 million. The company cited the increase in price of its online streaming plan from $7.99 to $8.99 as the primary reason for the decline in demand. While Netflix may have disappointed with its Q3 net subscriber additions, the fourth quarter is historically the strongest quarter for the company and the company added around 2.33 million subscribers for the same period a year ago. Also, the subscribers have had more time to absorb the price rise, so its impact will not be as strong as it was in the last quarter. We believe that Netflix’s US business could be entering its maturity phase and that the subscriber growth will be solid for the next couple of years but there will be less potential for surprises on the upside.

The International Segment Will Continue To Operate At A Loss

The international streaming segment is growing at a rapid pace. The number of international subscribers stood at 15.84 million at the end of third quarter of 2014, an increase of 72% over the same period a year ago. Netflix entered 6 new markets in Europe this year and has announced that it will launch in Australia and New Zealand next year. Even though the contribution margin for the first nine months of 2014 was -9% compared to -44% for the year ago period, we expect this number to come in at -14.5% for the full year 2014, as the expansion into new countries will put severe stress on margins in the coming quarters. This is primarily due to the lack of operating leverage that Netflix will face in these new markets, since the subscriber count will be low in the initial period and many new subscribers will be in the trial phase. Large marketing expenditure in the countries where the service has been recently launched is also unavoidable. All these factors will contribute to a period where the top-line growth will not generate profitability for the international segment of the company. However, Netflix is poised to benefit from its expansion in Western Europe in the long run as it has added about 66 million broadband households to its addressable market. ^[1] Netflix stated recently that its services launched in international markets prior to 2014 (Canada four years ago through to Netherlands one year ago) are now collectively profitable on a contribution basis,  ((Q3 14 Letter to shareholders, Netflix Investor Relations)) so we can expect the international services launched in 2014 to follow suit and become profitable in a couple of years. We expect that Netflix’s international segment will start having a positive contribution margin from 2016 onward.

Content Costs Will Continue To Rise Steadily For Netflix

Streaming content obligations increased from around $7.2 billion at the end of 2013 to more than $8.8 billion as of September 30, 2014, an increase of more than $1.6 billion in the first nine months of 2014. We expect this trend to continue for the fourth quarter and for years to come as Netflix will continue to bet big on content. Content expenses, which include the amortization of the streaming content library and other expenses associated with the licensing and acquisition of streaming content, are the largest cost component for Netflix and account for over 70% of the total expenses. However, Netflix will also begin to get returns on the investment the company has been making with respect to content. Netflix will broadcast an enviable roster of shows in 2015.  These include: First to consider are Daredevil and AKA Jessica Jones, which are parts of four planned Marvel series that focus on four of its characters that will culminate in an Avengers style team-up project.  There are also brand new seasons of the hit originals House of Cards and Orange is the New Black, as well as an original Adam Sandler comedy. Adding to this list are the second season of the $90 million dollar Marco Polo, the sci-fi series Sense8 created and directed by the Wachowskis, Tina Fey’s Unbreakable Kimmy Schmidt and a sequel to Crouching Tiger Hidden Dragon, among others. The broadcast of these original programs and movies will give Netflix an air of exclusivity in comparison to its rivals. Also, the win for Kevin Spacey (House of Cards) at the recently concluded Golden Globes Awards ceremony, along with the multiple nominations that Netflix’s shows received, demonstrate that Netflix has come of age as a content provider.

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1. Q3 14 Letter to shareholders, Netflix Investor Relations [↩] [↩]