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Netflix wraps up big Q3 as execs discuss M&A, competition, price increases

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Netflix wraps up big Q3 as execs discuss M&A, competition, price increases

It was a big three months since the last earnings call for Netflix Inc., with third-quarter earnings results being just one more headline.

The period included the company's first acquisition, the release of several new series, an increase in the price of Netflix subscriptions and increased competition as more content companies, most notably Walt Disney Co., take their shows and movies over the top for digital streaming and off of Netflix.

"It's a rapidly changing environment, for sure," Chief Content Officer Ted Sarandos said during an Oct. 16 earnings webcast.

On competition, the company's leaders said the platform has positioned well competitively and, rather than being concerned, they welcomed other companies innovating and driving forward the internet TV business more broadly.

The company is not concerned with access, as many of its distribution deals with Disney and elsewhere have multiyear commitments, so viewers have plenty of time to adjust to the changing content landscape. Some redistribution contracts cover the entire series, as is the case with "The Walking Dead," ensuring the second-window distribution of those shows will be on Netflix for the life of the show, Sarandos said. Further, Netflix is also co-producing films with certain content partners, like CBS Corp.'s All Access digital platform, which is co-producing "Star Trek Discovery."

"I think everyone's going to have their own strategies, and it's exciting. Everyone is trying to make over-the-top television better and better," Sarandos said.

Looking at M&A, the company during the quarter closed its first acquisition in its history, scooping up comic label Millarworld for an undisclosed sum. Millarworld created properties such as Kick-Ass, Kingsman and Old Man Logan. During the webcast Netflix executives fielded questions on the future of its acquisition strategy.

"We remain very, very focused, so we're not looking to diversify into new businesses, but rather looking opportunistically at intellectual property," Vice President of Finance and Investor Relations Spencer Wang said during the earnings webcast.

The executives went on to say that they will continue to look for similar selective opportunities in the future, but it maintains its bias to "build over buy," as Wang put it.

Further, Sarandos said the company had been circling Millarworld intellectual property for some time, so the efficiencies with a merger agreement were easy to justify.

Helping support the cost of future acquisitions, the company recently increased the prices of its streaming service. Past price increases have proven to be a bitter-sweet proposition, with the increases driving some membership churn and causing some earnings-season misses on net member additions. However, executives hope that with lots of new original content coming to the platform in the fourth quarter and 2018, most notably a second season of hit show "Stranger Things," the churn impact will be muted.

The company's strategy is to incrementally increase prices as the company increases the value of its platform with content additions, but with a patient, measured pace.

"It's really about slow and steady [growth]. We've been in no hurry," CFO David Wells said on the webcast. "Many investors in the past have criticized us for being underpriced."

However, it would be a mistake to assume there is a quantified correlation between price growth and content growth. Rather, the reception of new content by members drives longer-term decisions to adjust pricing.

Also, the company's pricing increases are on significantly different tracks in different markets globally depending on the pace and popularity of original content for each market.

Turning to quarterly financial metrics, the company reported a hefty third-quarter beat on memberships, driven in large part by better-than-expected international gains, even as it underperformed slightly on profits.

The company reported net membership additions of 5.3 million, well above guidance of 4.4 million issued during the company's July 17 second-quarter release. International member additions came to 4.45 million, compared to guidance of 3.65 million.

The membership beat translated into outperformance on revenue but lower-than-expected EPS.

Netflix reported total third-quarter revenue of $2.99 billion, up from $2.29 billion in the year-ago quarter and slightly above the $2.97 billion forecast in July.

On profitability, the streaming giant posted third-quarter net income of $129.6 million, or 29 cents per share, compared to $51.5 million, or 12 cents per share, reported a year prior. The EPS result comes in slightly lower than the 32 cents predicted in the July guidance.

The consensus EPS estimate for the third quarter was 32 cents, according to S&P Capital IQ.