On September 6th just after 11 a.m, T-Mobile (TMUS:NYSE) posted on their blog that they will begin offering T-Mobile ONE family accounts a free standard Netflix subscription. The offer begins tomorrow (September 12th). No end date to this offer was provided. These plans typically cost $9.99 per month. Post the announcement, Netflix’s stock closed at $179.25, 2.3% above its opening price.
Netflix Made this Move Because they were on Pace to Miss Q3 Guidance – According to our forecast model, Q3 2017 was pacing towards missing Q3 net subscriber addition guidance. Recall Ozark did not gain material traction despite Netflix’s relatively significant promotion. Netflix’s most popular shows on Google Trends continue to be Original series from last quarter such as “Orange is the New Black” and “13 Reasons Why”. In our previous report, we showed how the lack of popularity from new Q3 shows was likely pushing net subscriber additions below Q3 guidance of 4.4 million. We were estimating net subscriber additions of 4.0 million based on our forecast model. We believe Netflix made the decision to partner with T-Mobile in order to cover the likely shortfall in net subscriber additions they were on pace to see in Q3.
Netflix Will Need Outstanding Content and/or Other partnerships in order to continue 10% Y/Y+ Net Subscriber Growth Beyond Q4 – We forecast that Netflix will be nearing 53 million U.S. subscribers by the end of Q3/17 versus their long-term forecast of 60 to 90 million U.S. subscribers. U.S. subscriber growth continues at about 10% y/y. Given the timing with the T-Mobile offer starting only 19 days before the end of Q3, there will likely be a material impact to Q4 as well. However Q4 we believe will be the last quarter Netflix will see 10%+ y/y net subscriber growth.
T-Mobile has likely been waiting for Netflix to Act on Their Offer – T-Mobile’s primary motivation with this move is to push people off of grandfathered plans who may be tempted by the combination of Netflix and financing an iPhone 8 with a new plan. Netflix likely had the upper hand in negotiations given the time constraints T-Mobile was under with the upcoming iPhone release in late September. T-Mobile meanwhile likely did not have an idea that Netflix was under the gun with likely lower subscriber figures.
Our model Takes into Account a Wide Range of Variables – To measure the true impact this bundling of services will have on Netflix’s net subscriber additions for Q3 and Q4, we have forecast the impact by accounting for the following factors:
- We estimate 40% of postpaid subscribers are a part of a T-Mobile ONE family account (2 or more lines). We assume an average 2.5 subscribers per household. This brings us to 5.8 million family accounts eligible for a Free Netflix account.
- Assuming a normal Netflix penetration rate (47%) and assuming 5% of subscribers fail to “opt-in” for the free Netflix account, we see 2.9 million existing T-Mobile ONE family accounts being net subscriber additions for Netflix.
- With a better price/data/content proposition than AT&T (2 to 5 lines) and Sprint (for 4 to 5 lines) we estimate about 400K postpaid subscribers from these carriers transferring to T-Mobile in Q3 alone given normal monthly postpaid churn.
Through discussions with those in the industry and front lines, we found that family plans were very popular and account for perhaps the majority of new plan additions, but a smaller amount of the install base. We currently estimate family plan members with more than one line to represent about 40% of T-Mobile’s total subscriber base at the moment.
For our analysis, we have estimated the domestic subscriber additions as shown below.
EXHIBIT 1: Breakdown of Domestic Subscriber Additions
Source: Perspectec, Company Reports
Our Assumption on Q3 Net Subscriber Additions
Our base case assumes this promotion adds 3.3 million additional U.S. subscribers for Netflix with a large majority of these being recognized in Q3 and Q4. If we assume 40% of these eligible new Netflix subscribers activate win September, that is an additional 1.3 million subscribers. This would bring total net subscriber additions to 5.3 million versus the 4.4 million guidance, a healthy beat. The variance in the eligible accounts that ‘turn on” their free Netflix subscription we believe will be key to the significance of the beat.
Q4 Net Subscriber Additions – if we were to assume 50% of eligible T-Mobile accounts activate their free Netflix account in Q4, that would translate to just under 1.7 million net subscriber additions versus our 7 million net subscriber Q4 estimate. A 8.4 million net subscriber figure would be an outstanding figure and undoubtedly move the stock price higher at these levels. However it is still too early to have a strong conviction for Q4 results.
EXHIBIT 2: Expectations Summary for Q3 and Q4 2017
Source: Perspectec, Thomson Reuters
Conclusion – This partnership with T-Mobile should help Netflix beat the next two quarter’s net subscriber additions. In particular the revival of domestic net subscriber additions is material to Netflix valuation. Recall a U.S. subscriber ($315 lifetime value) is on average worth over 10x that of an International subscriber ($30 lifetime value). We believe Netflix stock should be purchased. However based on technicals, we believe investors should wait for either a better entry point or a strong technical signal.
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