Netflix Q2 Earnings: Stock Soars As Company Beats Guidance And Expectations

by Trefis Team
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Netflix‘s (NASDAQ:NFLX) stock hit an all-time high on Monday as the company posted its second quarter results, which were better than expected due to strong growth in subscribers. The company posted 32% year on year growth in revenues to $2.78 billion. The company’s international subscriber base increased at a rapid pace once again, while growth in domestic subscribers slowed a bit. Below we highlight the key takeaways:

  • Streaming revenues grew by 36% to 2.67 billion, while contribution margins improved by 200 basis points to 20.5%.
  • U.S. Streaming revenues improved by 24% y-o-y (2.3% q-o-q) to $1.50 billion. While paid memberships grew to 50.32 million (3 million addition y-o-y, 940,000 q-o-q), total membership grew to 51.92 million (4.8 million addition y-o-y, 1 million q-o-q). The quarter-on-quarter numbers indicate that the U.S. market is fast approaching maturation. Nevertheless, the contribution margins for the U.S. streaming services remain strong at 37%.
  • International streaming revenues grew by 44% y-o-y (11.38% q-o-q) to 1.12 billion. In Q2, the total membership for international streaming services exceeded to that of U.S. streaming services. Total membership grew to 52 million (16 million addition y-o-y, 4.14 million q-o-q), while paid subscribers grew to 50.32 million (14.82 million addition y-o-y, 3.72 million q-o-q). Despite the growth in subscriber numbers, the contribution margins were -1.1% as marketing and development (content) expenses impacted margins.

Based on Q2 results, we believe that Netflix’s overall subscriber base will continue to grow in the coming quarters, and paid international subscribers will overtake paid U.S. streaming subscribers in the coming quarters. For Q3, the company forecasts revenues will grow by 30% to 2.97 billion. The company also expects to add 4.4 million total subscribers in Q3, which is actually fairly conservative given the pace of additions in the international streaming businesses.

See our complete analysis for Netflix

Original Content To Drive Subscriber Acquisitions, Keep Competition At Bay

Despite intense competition in the subscription-based video on demand (SVoD) industry, the company continues to add subscribers. Its total membership stands at 104 million (across both the U.S. and international market), which exceeds Amazon’s Prime services (estimated 80 million) and Hulu (32 million).

Initially, the company had a first mover’s advantage through the licensing of third party content on its platform, but it had to change its strategy to acquire new subscribers and keep competition at bay. It primarily did this by venturing into the production of original content for its platform. This strategy has not only helped the company to retain and grow its subscriber base, it has also increased the popularity of the platform across the globe as some of its content has become extremely popular both commercially and critically, as evidenced by its Emmy nominations (91 nominations). In a recent move, some movies are debuting on Netflix first, a break from Hollywood’s windowing tradition (movies released in theaters). As a result, subscribers are signing up for Netflix to watch some of this exclusive original content, both movies, and TV shows.

We currently forecast domestic subscribers to grow to 68.7 million in the coming years, but the company may be able to surpass these forecasts if it continues to ramp up and maintain its popular slate of original content. If subscribers were to increase to 96 million (current household subscribers for Pay TV), there could be a 30% upside to our price estimate.

In international markets, Netflix is focusing on acquiring local third-party content and developing original content. Additionally, it is partnering with a wide variety of companies to increase its reach. This has led to impressive growth of over 53% (y-o-y) in revenues and 44% in terms of international subscribers. While we currently estimate that the international subscriber base will increase to 110 million by 2023, it can grow to 145 million due to these marketing and development efforts. If this were to materialize, there could be a 20% upside to our stock price estimate.

Original Content To Impact Margins And Cashflows In The Short Term

While the company initially licensed original content exclusively produced for its platform from companies such as Lionsgate and Disney, it is now developing and producing its original content, including hits such as Stranger Things. This content has been valuable for the company in terms of attracting subscribers, it does require significant upfront investments. The company plans to fund these investments largely through debt. Debt funding would not only help the company to lower its cost of capital, but also help it to ramp up the production process, particularly in international markets.

Netflix spent around $4.1 billion on content in the first half of 2017, a 40% increase from $2.96 billion in the prior year period. The company has stated that, considering the success of its original content strategy (as reflected in net additions to its subscriber base), it plans to deploy increased capital on content, particularly in owned originals. Therefore, the company expects to have negative free cash flows for the foreseeable future. This will be the case in 2017, when it expects a free cash flow of -$2.0 to -$2.5 billion due primarily to content expenditures.  However, once this original content has been produced, the content library can be monetized and amortized over a number of years, which should lead to an improvement in profitability over the long run.

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