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Netflix Q3 earnings, subscriber beat comes at cost, competition

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Netflix Q3 earnings, subscriber beat comes at cost, competition

Netflix Inc. on Oct. 16 reported a big subscriber and earnings beat for the third quarter, but executives on a same-day earnings webcast acknowledged that deeply negative cash flow will persist for years and eventually OTT competition could be a concern.

The membership beat is likely more due to problems with internal accurate forecasting than with any dynamics in the business itself, CEO Reed Hastings said on the call. He said by focusing on trends in net additions of paid subscribers rather than total subscribers, the company may be able to offer more accurate guidance going forward.

Netflix reported almost 7 million streaming customer additions in the quarter, well above its guidance of 5.0 million, with international additions of 5.9 million leading the growth. The company saw paid net additions climb by 6.1 million, and forecast 7.6 million more in the fourth quarter.

On third-quarter financials, Netflix beat consensus forecasts for net income, which clocked in at $402.8 million, or 89 cents per share, against the S&P Global Market Intelligence consensus EPS estimate of 68 cents. However, its forecast for free cash flow was a loss of about $3 billion for full year 2018, outpacing some expectations as cash flow burn is expected to accelerate in the fourth quarter. Year-to-date, free cash flow was in the red by $1.7 billion, the company said in the same-day earnings release.

CFO David Wells on the call said 2019 free cash flow is expected to flatten out at roughly the same $3 billion loss rate as full year 2018, indicating that the company is leveling out its financials to reverse the momentum in 2020 and beyond, even if it is years from breaking even. The majority of the company's cash flow burn goes to content spending, which is projected to crest at about $8 billion in 2018.

"Netflix is approaching a point where the growth in operating profit is going to grow faster than our growth in content cash spend, and that's really going to drive the free cash flow toward improvement," Wells said.

On increasing competition, the global internet TV market is large enough to accommodate multiple platforms, and so far the additional platforms have not had a large impact on Netflix, Hastings said, reiterating a common refrain on his earnings calls.

"Of course [Walt] Disney [Co.] is going to enter. AT&T [Inc.] is going to expand HBO. [Alphabet Inc.'s] YouTube is just on fire, growing around the world. Video gaming like Fortnite, there's so many ways to have great entertainment on a screen. So we don't focus that much on any one, because no one seems to affect us that much. What affects us is, can we produce the best content the world's ever seen?" the chief executive said.

He did acknowledge that someday there will be competition for OTT consumer wallet share, but said that "seems a long way off."

However, Chief Content Officer Ted Sarandos said competition is impacting the content-buying business as more companies pull movies and TV shows off Netflix to put on their own new digital platforms.

"We've been a pretty dependable buyer, and increasingly the sellers have been more complicated sellers," he said.

As companies pull content off the platform, Sarandos said the most valuable way to replace that volume is with Netflix owned and produced originals. Currently, the companies' owned and produced content is a small fraction of the available content on the platform.

On alternative forms of content and monetization, like Netflix's recent partnership to put clips of its stand-up comedy specials on Sirius XM Holdings Inc. satellite radio along with originals and talk shows, the executives said that while it does provide exposure to Netflix content at times that consumers may not other ways have access, like while driving, those efforts are not new businesses but intended to drive the core business.

"Our auxiliary efforts are not around creating additional profit streams for now. They're really aimed around strengthening these megatitles because that’s what drives the business, and a little bit of incremental growth is much more profitable for us than creating separate businesses," Hastings said.