Netflix Hits New Record High After Smashing Subscriber Expectations, Unveils $17 Billion In Content Commitments

Tyler Durden's picture

After some initial confusion, Netflix stock surged after hours, a repeat of what it did last quarter, soaring above its all time high price, up over 2% after reporting Q3 numbers which while beating slightly on revenues ($2.99Bn, Exp. $2.97Bn), and beating modestly on non-GAAP EPS (GAAP EPS$0.29, non-GAAP EPS $0.37, exp. $0.32), were far more remarkable for the subscriber numbers, which smashed expectations as follows:

  • Q3 total net streaming additions 5.3 million, Exp. 4.5 million
    • Q3 domestic net streaming additions 850,000, exp. 774,000
    • Q3 international net streaming additions 4.45 million, exp. 3.72 million

The addition of 5.2 million subs in Q2 was the largest increase ever during the period, which traditionally is among the company's slowest time of year.

Netflix' Q4 outlook was in line with expecations and the company now expects Q4 net streaming adds of 6.3 million (1.25m in the US and 5.05m internationally) just fractionally higher than the consensus estimate of 6.29 million and below the 7.05 million in the year ago quarter (which was the company's all time record high quarter).

The company expects $3.27 billion in Q4 revenue, also above the consensus estimate of $3.15 billion, generating net income of $183 million.

One thing that investors will focus on is the company's content spend for next year, which Netflix is increasing once again: having previously said they would spend $7 billion, they are raising that by as much as a $1 billion, forecasting that "we’ll spend $7-8 billion on content (on a P&L basis) in 2018."

Also, it will come as no surprise that with Wall Street expecting the company to spend $8.7 billion this year on content...

... it will continue spending an ungodly amount. Netflix now has 109.2 million subscribers worldwide, but the success has come at a steep price and as of Sept.30, NFLX's total content obligations were a record $17 billion.

The company's historical content spending is as follows:

  • 2018: $7-$8 billion (forecast)
  • 2017: $6 billion
  • 2016: $5 billion
  • 2015: $4 billion
  • 2014: $3 billion
  • 2013: $2 billion

Also, as one would expect, the company remains in its near-record cash burning ways, reporting that in Q3 it burned $464 million, modestly below the $608 million it burned last quarter, and $506 million one year earlier.

Discussing its relentless cash burn, Netflix said its negative FCF, that despite growing operating income, "is due to growth of our content spend, original content in particular, where we pay for the titles before consumers enjoy the content, and the asset is amortized by estimated viewing over time. We anticipate financing our capital needs in the debt market as our after-tax cost of debt is lower than our cost of equity."

Below are some more highlights from Netflix' letter, first focusin on subscribers:

Global streaming revenue in Q3 rose 33% year over year, driven by a 24% increase in average paid memberships and 7% growth in ASP. Operating income nearly doubled year-over-year to $209 million with our Q3 global operating margin of 7.0% putting us right on track to achieve our full year target of 7%. EPS of $0.29 included a pre-tax $51 million non-cash loss from F/X remeasurement on our Euro bond (or $39 million after tax based on a 24% tax rate). Higher than expected excess tax benefit from stock based compensation benefited our tax rate by $5 million vs. our forecast. As a reminder, the quarterly guidance we provide is our actual internal forecast at the time we report. We added a Q3-record 5.3 million memberships globally (up 49% year-over-year) as we continued to benefit from strong appetite for our original series and films, as well as the adoption of internet entertainment across the world. Relative to our guidance of 4.4 million net adds, we under-forecasted both US and international acquisition. Year to date net adds of 15.5 million are up 29% versus last year.

On the the domestic vs international margin, and why the first missed while the second beat:

Domestic contribution margin in Q3 of 35.8% vs. 36.4% last year was below our forecast of 37.1% due primarily to the earlier-than-anticipated close of certain content deals. The foreign currency impact in the quarter was +$13 million and Q3 international revenue grew 54% year over year, excluding currency. F/X-neutral ASP increased 7.4% year over year. International contribution profit margin of 4.7% exceeded our 2.3% guidance, also due to the timing of content deals.

On the company's guidance:

For Q4, we forecast global net adds of 6.30m (1.25m in the US and 5.05m internationally) vs. 7.05m in the year ago quarter (which was our all-time high for quarterly net adds). We recently announced price adjustments in many markets to our HD and 4K video plans while keeping our SD plan mostly unchanged (still $7.99 in the US, for instance). Existing members will be notified and their prices will be adjusted on a rolling basis over the next few months. Increased revenue over time will help us grow our content offering and continue our global operating margin growth.

Here is the warning that the company's contribution margin will decline as it focuses on marketing:

We’ve been focused on growing global operating margin as our primary profitability metric since hitting our 2020 US contribution margin goal of 40% this past Q1. This allows us to avoid near term optimization for specific domestic or international contribution margin targets which could impede our long term growth. For instance, we anticipate our Q4’17 US contribution margin will be 34.4% (a decline both year-on-year and sequentially) as we boost our marketing investment against a growing content slate. We spend disproportionately in the US to generate media and influencer awareness for our programming which we believe, in turn, is an effective way to facilitate word of mouth globally. In our international segment, we are on track to generate positive contribution profit for the full year. As we move into 2018, we aim to achieve steady improvement in international profitability and a growing operating margin as our success in many large markets helps fund investments throughout Asia and the rest of the world.

Perhaps most important, is the discussion of the Netflix content portfolio and the gargantuan content commitments:

Investors often ask us about continued access to content from diversified media companies. While we have multi-year deals in place preventing any sudden reduction in content licensing, the long-term trends are clear. Our future largely lies in exclusive original content that drives both excitement around Netflix and enormous viewing satisfaction for our global membership and its wide variety of tastes. Our investment in Netflix originals is over a quarter of our total P&L content budget in 2017 and will continue to grow. With $17 billion in content commitments over the next several years and a growing library of owned content ($2.5 billion net book value at the end of the quarter), we remain quite comfortable with our ability to please our members around the world. We’ll spend $7-8 billion on content (on a P&L basis) in 2018.

On competition and usage, where everyone is jumping in:

Since 2013, we’ve taken the Long Term View that we’re in the early stages of the worldwide, multi-decade transition from linear TV to internet entertainment. Recently, it’s been unfolding right before our eyes: Disney announced plans to launch direct-to-consumer services for ESPN and its other brands, cable network owners are licensing their channels to virtual MVPDs like Hulu, YouTube, Sling TV, and DirecTV Now, CBS’ All Access is expanding internationally, Apple is reportedly planning on spending $1 billion on original content and Amazon is streaming NFL games while its Prime Video service has gone global. Facebook launched its Watch tab for original videos. At the same time, linear TV networks like MTV, A&E and WGN are cutting down on scripted series. Last year, the number of original scripted series on linear TV (across broadcast, premium and basic cable) began to decrease as online services ramped up activity.

Finally, on cash burn:

Free cash flow in Q3 totaled -$465 million vs. -$506 million last year and -$608 million in Q2’17. There is no change to our expectation for FCF of -$2.0 to -$2.5 billion for the full year 2017. Negative FCF, despite growing operating income, is due to growth of our content spend, original content in particular, where we pay for the titles before consumers enjoy the content, and the asset is amortized by estimated viewing over time. We anticipate financing our capital needs in the debt market as our after-tax cost of debt is lower than our cost of equity.

Judging by the afterhours stock response , investors are far less worried about the relentless cash burn, and the $17 billion in already accrued content commitments, and instead are are more impressed with the subscriber additions, as a result sending the stock over 2% higher.

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JoeTurner's picture

"Paging Mr. Madoff, Mr. Bernie Madoff a Mr. Hastings on Line 2..."

Rainman's picture

makes ya wonder who is on the other end of the ' cash burn '.

p/e 250

jcaz's picture

Yep- shrinking margins, no control over it, and new competition popping up left and right- bullish!

5.5% acid test- yikes.....

Stuck on Zero's picture

105 million bot subscribers have got to cost a fortune.

GUS100CORRINA's picture

Sorry to make this point, but NETFLIX is growing because mankind is growning in CORRUPT and SINFUL behavior. Video combined with DEMONIC Music is the OPIOID of the Millennials. AMAZON will grow as well. There is a lot of BAD content being produced daily for public consumption is unhealthy to watch.

As a side note, NETFLIX P/E is over 300. NETFLIX is the new definition of GARP.

Four chan's picture

short this and all other deliverer of content, like the msm their time is over.

ejmoosa's picture

If Gerald's Game is any indicator, they need to quit producing their own content.

Juggernaut x2's picture

I wouldn't watch Netflix if I got it for free. It is all mind pollution. 

fx's picture

house of cards was fun, though.

Didn't watch it on nflx. Never will use this scam company's service.

pedro314's picture

The Trump bubble will be tre greatest ever....

Consuelo's picture

 

 

Not 'tre'.

It's: 'teh'...

TheSilentMajority's picture

Cut the cord with netflix.

All the netflix content + everything else available on the web is free if you just buy a $30 google Chromcast dongle and plug it into the back of your tv.

adr's picture

Yeah, but you have to use your phone for everything.

What's really cool is screen mirroring from a laptop.

Hongcha's picture

This is the last bubble for a long time, so they are blowing really, really hard.

This reminds me of a new keg going online at 3:00 a.m. ...

pods's picture

Netflix is being held up only by their ability to pass bandwith costs to ISPs.  

pods

gatorengineer's picture

Funny, I thought I paid for my bandwidth, silly me.... $12 to netlfix $60 dollars to my ISP......

ToSoft4Truth's picture

I recently got a Netflix account. 

 

"Trading Places" was recently 'new' on the list of streaming movies.  The movie is 40 yeas old.

 

I'm cancelling. 

CoCosAB's picture

Dumb slave! Wasting money to verify if SHIT is really SHIT!

adr's picture

Doubling since last year when Netflix already had a triple digit P/E.

I really don't know what people watch on Netflix because the shows are horrible. New movies are non existent.

I guess people don't give a shit because it cost $8 a month. With the price hikes more people will probably drop it, when the Disney movies go poof, so will millions of subscribers.

The cash burn will only accelerate, but somehow like Tesla and Amazon, Netflix can lose money and still hit record highs every week. 

It will cost Netflix double whatever they bring in for a subscription fee to produce content. Reminds me of Moviepass. How long can a company survive selling something for less than they pay for it?

ejmoosa's picture

The networks suck more...so it is all relative.

JDFX's picture

The wife likes Netflix. It's going much higher..... Because the wives like Netflix ! 

1stepcloser's picture

Vibrator stocks should of been the play for last 85 years with that logic

LeftandRightareWrong's picture

What even made you think of that?

shadow54's picture

I had netflix when it first came out. There is no way you can see the whole list of movies, just selections for you. It was good for TV shows, that  is it. I cancelled.

All of these contents site track everything and intrude into your home equipment.

It is easier to use torrents with a vpn like privateinternetaccess.com/ which only cost $3.33 month to download content without being tracked.

scam_MERS's picture

I don't even bother to download anything anymore, I can find pretty much anything streaming free at primewire.ag, or use a media search engine like alluc.ee (it's like Google for stuff to watch free) - then watch it with Opera browser which has a free, user selectable VPN in different countries (for the paranoid). Why pay for any of it?

freedom1798's picture

Netflix was good a few years ago when they had decent movies.  Now the movies are all shit and I have zero interest in their "content".  I cancelled about a year ago.  No regrets. 

Squid Viscous's picture

the ponzi continues, now it's a verb i'm hearing, as I'm going to Netflix all weekend,

fucking loser generations we have created,

taggaroonie's picture

woohoo, just when I had a great idea for a movie

yellowsub's picture

Did they take into account how T-Mobile is offering or subsidizing customers with free Netflix for signing for some plan they offer?

Squid Viscous's picture

those are counted as new subs, #winning!!

LeftandRightareWrong's picture

The economy must be MUCH better than the stats show.  Where do people find time for FB, Netflix, twitter, instagram, youtube ... ZH?

Barney08's picture

NFLX a true House of Cards. Wonder what HBO's peak valuation was?

majik's picture

Only 108 million subs worldwide,  a lot less than I thought.

The quality of Netflix's offerings has decreased considerably. They heavily market their own content which is very hit or miss in a 10:90 ratio. They don't even let you finish a movies credits anymore, it is always interrupted by a promo for their own content.

Their third party content is subject to rolling licensing windows. A movie may be on the system for 6 months and then disappear. Older movies appear and disappear multiple times over 24 month timescales. It's a mess. Sites like instantwatcher.com allow you to actually see what quality content there it.....very little.  For exampe instantwatcher lists about 6900 pieces of content to watch on Netflix. Want to watch some classic movies from the 60's & 70's you'll have a delightful 60 movies to choose from, or how about some movies from Hollywood's Golden Era? You'll be searching through a paltry selection of 30 items, what a joke.

Netflix is setting itself up for huge fall. Their is a huge disconnect betweens the subs, content production and third party licensing, all separate parts of the business. Of course right now it is probably a lot cheaper for Netflix to generate their content rather than endlessly licensing third party BUT this has to be backed up by high subscription fees because the cash flows are huge. As the cost of producing the content increases over time the price of the subs has to go up. But here is the catch, the cost of licensing third party cotent is actually going to decrease in the future as rights holders now have multiple platforms on which to show their content. The danger for Netflix is that they could be left holding the bag so to speak, purveyors of a vast catalogue of their own content that nobody wants to watch.

 

milking institute's picture

Excellent analasys,btw,the ONLY reason they scrapped the star rating system was the poor (one * average rating) for most of their own productions. but instead of listening to the audience they decided to silence them. not a smart move imo,just shows lack of confidance in their product. when Adam Sandler becomes the centerpiece of your offerings you've got problems....

Caciqué's picture

if Netflix manages to rake in ever more billions until the competitors are dead in the water they will earn money head over fist.
Classic monopolistic gains, like FB and Google

majik's picture

You think firms like Google and FB actually make money? Wait for the ass to fall out of the advertising business for them both. The game is up, the three major advertising holding companies WPP, Omnicon and Dentsu are up in arms about the lack of transparency in both Googles and FB's advertising metrics. All advertising networks are pulling back from digital. Digital advertising has just become another neccessry evil for the advertisers but definitely not the silver bullet that most were predicting. It's probably no more effective than branded urinal cakes. Both firms realise this and are rapidly growing their 'other' sides of their businesses.

Disgruntled Goat's picture

Procter & Gamble recently cut out all advertising on Facebook. Know what happenned? Not a fucking thing. No impact on sales whatsoever.

Disgruntled Goat's picture

Not with 3% net margin.... theyre burning through billions, not raking it in.

Disgruntled Goat's picture

The only thing that keeps them afloat is free ample bandwith for which they incur zero cost. Thats what "net neutrality" was all about. When they, or their subscribers face some type of bandwith cost or cap, thats it for them. Trading aroung 200 bucks with a PE of 250... hmmmmm..... an attractive price might be around $10... another sick joke

milking institute's picture

You are correct,besides,75% of their inhouse productions are garbage. on the other hand, 10 bucks a month are a good deal for what you get,the stock, not so much...

brewing_it's picture

One word...WorldCom

Flounder's picture

So who are these people who pay Netflix to give their lives content?