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Soid Ahmad
Soid Ahmad
Articles (195)  | Author's Website |

Netflix Posts Solid Results

Company beats subscriber expectations, improves margin. Content costs rise further

April 16, 2018 | About:

Netflix Inc. (NASDAQ:NFLX) reported its results for the first quarter of 2018 Monday, beating the top-line estimate. Earnings per share were in line with the analyst consensus.

Revenue grew 12.6% to reach $3.7 billion. Analysts were hoping for $3.69 billion. Earnings per share were 64 cents for the quarter, up 60% on a year-over-year basis.

The number of subscribers reached 125 million, up approximatley 6% sequentially. Net additions amounted to 7.41 million, down 11% sequentially and up about 50% on a year-over-year basis. The company now has 55.1 million domestic subscribers and 63.9 million international subscribers. Net international additions came in ahead of FactSet's expectations of 5.02 million.

The stock rose approximately 7% on the revenue beat and strong earnings guidance for the next quarter. Netflix is guiding for revenue of $3.9 billion for the second quarter, translating into earnings of 79 cents per share. Analysts were guiding for earnings of 64 per share for the next quarter.

Subscriber insights

Source: First-Quarter 2018 Shareholders’ Letter

While the numbers for both domestic and international subscribers are growing, the growth in domestic subscribers is slowing down. International subscribers are up an impressive 40% over the trailing 12 months. Domestic subscribers, on the other hand, managed to post 10% growth during the quarter. Net additions are also slowing down on the domestic front.

First-Quarter 2018 Shareholders’ Letter

Net additions are expected to decline in the second quarter. However, Netflix usually adds more subscribers in the first and last quarters of the year.

Nonetheless, domestic net additions declined 24% in the first quarter of 2017; they are projected to decline 38% during the second quarter. On the international front, the momentum has also started to shift. Although international net additions grew 17% in the prior-year quarter, they are expected to decline 8% in the second quarter.

All in all, the momentum of subscriber additions is slowing down. Note, however, that slowdown in net additions doesn’t mean the number of subscribers is declining.

Content costs and margin

Cost of revenue was $2.2 billion for the quarter, up 32% on a year-over-year basis. The operating margin improved 300 basis points on a year-over-year basis to reach 12%. Netflix continues to spend on content as cost of sales made up around 60% of revenue in the first quarter.

Content amortization was around $1.7 billion for the quarter, up 33.8% on a year-over-year basis. This translates to an annualized amortization of $6.8 billion.

In simple terms, Netflix has to spend $6.8 billion a year going forward to maintain its content library.

Due to a smaller window of availability for licensed content, content assets increased about $3 billion over the trailing 12 months despite the company recording $6.5 billion in content expenses over the same period.

With these content-related obligations, the company will continue to remain cash flow negative in the quarters to come. Netflix plans to satisfy its operational needs by increasing debt. The company is expected to shed -$3.5 billion in operating cash throughout the year.

"We have about $2.6 billion in cash and we will continue to raise debt as needed to fund our increase in original content. Our debt levels are quite modest as a percentage of our enterprise value, and we believe the debt is lower cost of capital compared to equity."

What does this mean for investors?

The stock jumped on solid net additions with improved margins. On the flip side, the stock is already trading on the high side. Netflix has to consistently grow in a similar fashion in the future in order to justify the current valuation. Although the stock is trading high on subscriber growth, content costs and low margins make Netflix a risky bet going forward. Even a slight slowdown in subscriber growth can materially hurt the stock price.

Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.

About the author:

Soid Ahmad
Soid Ahmad is affiliated with the Association of Chartered Certified Accountants. He graduated from Oxford Brookes University. He also holds a Master's degree in Economics and Finance from HSRW Germany. He has been working as a technology analyst for several years and has an eye for mispriced technology stocks. He is also affiliated with Focus Equity, an independent equity research firm.

Visit Soid Ahmad's Website

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