by Clement Thibault
Netflix (NASDAQ:NFLX), the premium internet video service, reports Q3 2016 earnings on Monday, October 17, after the market closes.
1. Earnings and Revenue
According to Wall Street consensus, Netflix is expected to report EPS of $0.05 on $2.28 billion in revenue. Neither EPS—which is down almost 30%—nor revenue—up 31% partly because of Netflix's recent subscriber price hike—are the key metrics for Netflix. As we've pointed out previously, expanding the subscriber base is considered the primary driver of Netflix's growth.
2 U.S. Subscribers
For companies like Netflix, market penetration is critical, and subscriber growth is the one metric investors shouldn't ignore. Netflix is projecting 300,000 new subscribers domestically, and Wall Street expectations are even higher, 351,000 for the quarter. Last quarter, the expectation for new subscribers in the U.S. was 500,000. Netflix reported growth of only 160,000. The stock fell 13% after the company reported.
According to M Science, an investment research company, NFLX investors are in for another rude surprise this quarter: the company will fall short of its U.S. subscriber goals by 300,000. Yes, you read that correctly, the research firm is projecting domestic growth of zero subscribers. It could be the price hike caused long-time subscribers not to renew, which could have potentially offset new registrations. If M Science is correct, and the price hike hurt Netflix to the point of zero growth, management should be asking some serious questions about its pricing power ...and pricing savvy.
3. International Subscribers
Currently, 57% of Netflix subscribers are from the U.S., where the market is slowly settling down even as the competition from services such as HBO and Hulu ramps up. It makes sense, therefore, that most of Netflix's big growth is expected to come from abroad. Indeed, of the expected 2.3 million new subscribers forecast, 2 million will likely come from outside the U.S. Still, if you revisit last quarter's results, expectations then were also for a 2 million subscribers, but only 1.5 million customers joined Netflix's streaming services.
The good news is that the U.S. is by far the market most inclined to purchase video streaming on demand, where according to a survey by futuresource consulting, about 61% of Americans use such services, compared to 33% of consumers in the U.K, 30% in Germany, and only 11% in France. As Europeans jump on the streaming bandwagon, Netflix should see a rise in internationals subscriptions. Unfortunately, the exact moment that cultural switch might take place is impossible to predict.
4. Content Production
Over the past few years, Netflix has made aggressive moves in the content production front, spending millions on television shows such as House of Cards, Orange Is the New Black, and Unbreakable Kimmy Schmidt among others, with 14 new shows coming in 2017. According to the company's Chief Content Officer,Ted Sarandos, Netflix will continue producing high profile TV series', which the company believes is an investment that's both efficient and highly appealing to new customers.
Netflix's productions are definitely a draw, having garnered 17 nominations and 3 Emmy awards last year (third behind HBO and FX). Still, awards don’t necessarily drive revenue though the perception of quality and hot-show buzz do have their benefits. Nevertheless, content creation is an expensive proposition. In early 2016, Sandros said:
"We're going to spend in 2016 about $5 billion dollars on content on a P&L basis, which means about $6 billion in cash."
That's a significant sum for something that's a lot riskier than Netflix's original business model, licensing and streaming content. Netflix is working on content for markets outside the U.S. as well, including Brazil, Germany and India, hoping to grow both its audience and its brand recognition in all those countries.
5. Strategic Partnerships
Netflix continues to make efforts abroad by partnering up with cable providers, in order to package Netflix in addition to standard cable. After securing a deal with longtime competitor Comcast (NASDAQ:CMCSA) in July, offering Netflix on its new X1 platform.
Netflix and Liberty Global (NASDAQ:LBTYA), the world's largest international TV and broadband company with broadcast outlets Europe, Latin America and the Caribbean, have announced a similar deal. The agreement is beneficial for both sides, as it bolsters the cable company's offering, as well as potentially facilitates new customer acquisition for Netflix. Adding customers through cable companies surely hurts Netflix's profit margins as the company has to pay a middleman, but because the market is so focused on subscriber growth, it’s a good move. It also familiarizes potential users with Netflix's services, and positions the company well should cable customers decide to cut the cord and go streaming-only.
Most recently, in early October, Netflix inked a deal with iPic Entertainment, a Florida-based operator of luxury movie theaters. According to the terms of the deal, 10 upcoming Netflix original productions will debut simultaneously in iPic theaters in New York City and Los Angeles, while streaming on Netflix itself. In addition, the theater chain has the option of screening the Netflix productions in its 13 additional theaters as well. Aside from the possibility of adding additional, box-office, revenues to its bottom line as well as reaching out to yet more potential subscribers, it seems likely Netflix had an additional item on its agenda for the deal. By having its original content screened in New York and LA for at least one week, these Netflix productions become eligible for Oscar consideration. An Academy Award, alongside those Emmys, might surely add a bit of additional luster to the Netflix brand.
Conclusion
Last quarter we wrote about unrealistic expectations for Netflix, based on its P/E ratio. At that time we said:
"Netflix will find it harder to sustain the growth trend Wall Street has come to expect, which will in turn lower expectations—but not before hammering the stock a few times."
Unfortunately, and even though Netflix lost 13% of its share value after its Q2 2016 report because of disappointing growth, when the stock opened at $85.43, down from $98.81 the previous day, Wall Street once again seems to expect more of Netflix than the company dares expect of itself – which is never a good sign.
Though we believe Netflix is a good company, and will continue to sit at the top of its industry in years to come, it is not a monopoly, nor does not operate in a vacuum. We think at $101.47 as of Friday's close it's priced excessively high, based on lofty future expectations. Right now, Netflix's upside is already firmly priced in.