Netflix reported better than consensus net subscriber additions that were generally anticipated by the market with the run-up in NFLX prior to the Q3/17 report. Netflix remains in a class with NVIDIA as the only large ‘tech’ companies able to raise prices and still see increasing demand of its products.
Q3/17 results were in-line with our expectations. In particular, net subscriber additions were 5.3 million versus our forecast of 5.2 million and in comparison to the guidance of 4.4 million. Q4 guidance for net subscriber additions was 6.3 million versus our estimate of 7.4 million, but as we talked about in our preview, we believe Netflix is sandbagging its subscriber forecasts as it again in Q3.
Financials are in line with our expectations- The company reported revenues of $2.99 billion, within 0.2% of our estimate of $2.8 billion vs the company’s guidance of $2.69 billion. The gross margin of 33% and operating was 7%, short of our estimates of 34% and 8% respectively. This is attributable to the earlier-than-anticipated close of certain content deals (as per the letter to the shareholders) as well as higher than anticipated marketing costs. While the EPS of $0.29 was below management’s guidance and consensus, it matched our expectations.
The table below summarizes the above-mentioned metrics.
EXHIBIT 1: Q3 Results and Q4 Estimates
Source: Perspectec, Company reports, Factset and Thompson One
Our regression model is was accurately tracked Global net subscriber additions – Our multiple regression model forecasted 5.15 million Global net additions vs 5.3 million actual net additions. As mentioned in our previous report and affirmed by the management, the additions for the quarter have been driven to a great extent by well-established and globally recognized Originals such as Orange is The New Black, House of Cards, Narcos and 13 Reasons Why. Most of the shows making the big impact were released before Q3. Despite the lack of strong new content International net subscriber additions beat our forecast 1.3 million. We are adjusting our forecast model to increase the weighting of market penetration in determining net subscriber additions. Previously our model focused only on Global demand.
T-Mobile partnership had a smaller impact than predicted – We estimated the impact from T-Mobile to be just over 1 million subscribers in Q3. However, it seems the impact was perhaps 10% of our estimate. In the end US net additions of 0.85 million were materially less than our expected 2 million net additions. We have reduced our expectations on net subscriber additions from this deal.
Q4 appears ripe for a beat – We believe Netflix has provided conservative net subscriber addition guidance for Q4 at 6.3 million. We currently expect this to be more in the range of 7.4 million. Q4 has a stellar line-up of Originals including the highly anticipated second seasons of Stranger Things and The Crown, new releases such as Mindhunter, Marvel’s The Punisher, Bright, as well as Foreign language shows like Suburra and Dark.
Before the announcement of the price hike in the U.S. and earnings release, we expected domestic subscribers to grow by 1.5 million. Based on historical evidence, we now expect the number to be closer to their guidance of 1.25 million. This leaves us with 6.1 International subscriber additions. Revenue for the quarter is expected to be $3.32 billion, with an operating margin of 7.6% and an EPS of $0.40.
We shall be updating our estimate over time as we can measure the performance of the Q4 releases.
SaaS Metrics and Valuation
Taking the results at face value, the materially stronger Y/Y EBITDA ($229 million versus $120 million in Q3/16) and lower churn coming out of our U.S. and International surveys are material positives to our target price. Our CLTV / CGC increases from an expected 1.16x to 1.36x. Churn in the U.S. has decreased from about 17% in Q3 to 13% at the end of Q3 according to our surveys. See the valuation section for details.
Other Points which we will look at over the coming months:
Impact from Pricing – Starting October 19th, Netflix will begin notifying the 2-stream and 4-stream HD U.S. customers that their prices will increase in 30 days by $1 and $2 a month respectively. They are also increasing prices in some overseas markets such as Australia, France, Britain and Germany. We will likely get into more sensitivity analysis as to what the impact could be on net subscriber additions from this.
Higher cost of debt? – Another factor to consider is the high Net Debt/ EBITDA ratio of 3.2x. While the company’s argument to fund spending with debt is a lower cost of capital, the Net Debt/EBITDA could make it more expensive to take on debt.
Value of a U.S. subscriber remains 10x that of an International one – Our CLTV estimate for a U.S. subscriber in Q3 is $426 versus $44 Internationally. U.S. gross margin and churn continue to be materially better than their International peers.
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For the purposes of complying with NYSE, NASDAQ and all Self-Regulatory Organizations, Perspectec Inc. has assigned the following rating system BUY, HOLD/NEUTRAL, SELL for the securities which are the views expressed by an analyst, Independent contractor, and or an employee of Perspectec Inc. The information and opinions in these reports were prepared by Perspectec Inc. or an analyst, independent contractor. Though the information herein is believed to be reliable and has been obtained from public sources believed to be reliable. Perspectec Inc. makes no representation as to its accuracy or completeness.
