The rest of the FANGs may be crashing and burning, but one "story stock" refuses to give up: Netflix.
Moments ago Reed Hastings ubiquitous streamer of videos right into your bedroom reported Q4 EPS of $0.10 (vs the $0.08 expected), on $1.82BN in revenue, a fractional miss to expectations, however as everyone "knows", Netflix does not trade on fundamentals.
What does it trade on?
Well, the story is simple: all about "eyeballs" or in this case, subscriber data, and here it gets a little dicey, because while NFLX reported a miss in net domestic adds which at 1.56 million were just fractionally lower than the 1.62 million expected, and perhaps more troubling: Q4 US net adds were down year over year, 1.56m actual versus 1.90m prior year. But it was the surge in low-margin, high cost international subs that saved the day: at 4.04 million, this number was far above the 3.5 million expected.
Additionally, as part of NFLX' guidance, while the domestic growth appears to be tapering, with the company expecting 1.75MM net adds in Q1 2016, down from the 2.28MM a year ago, it predicts a surge in international net streaming subs, which should grow by 1.75MM from a year ago to 4.35MM.
Some more findings: Q4 total streaming contribution margin of 16.2% declined to the lowest in 2015 driven by the drop in the international streaming loss, which at ($109) million, was a -19.2% profit margin, versus the 34.3% domestic profit margin.
In other words, while NFLX domestic growth appears to be trailing off, this will be the cash flow basis which the company will use to grow internationally, even if so far at least the profit contribution from offshore is wildly negative.
And a little more to the "story" from the letter:
In September, we launched in Japan, followed by Spain, Portugal and Italy in October. We are very pleased with the first few months of membership growth in these markets. Our international contribution loss of $109 million in Q4 increased sequentially due to these launches. We anticipate Q1 international losses of about $114 million.
In early January at CES, we announced the availability of Netflix everywhere in the world except China. Pricing is comparable to our existing plans and we have added support for Korean, Arabic, and Simplified & Traditional Chinese languages. Our move into 130 additional countries broadens our addressable market by 190 million broadband homes, on top of the 360 million we counted at the end of 20151. While the opportunity is large, our growth in these new markets will unfold over many years as we improve our service. We are starting by primarily targeting outward?looking, affluent consumers with international credit cards and smartphones. As with every market we’ve launched, our approach is to listen, learn and improve rapidly, adding more content, additional languages and a better Netflix experience over time. Our global availability sets us up for continued growth for many years and we continue to expect material global profits beginning in 2017.
In the US, we ended 2015 with nearly 45 million members, although our Q4 US net adds were down year over year, as expected (1.56m actual versus 1.90m prior year). Our high penetration in the US seems to be making net additions harder than in the past. Our forecast for Q1 US net additions is 1.75m, against a prior year actual of 2.28m. New credit/debit card rollover continues to be a background issue. In Q2 and Q3, we’ll be releasing a substantial number of our US members from price grandfathering on the HD plan and they will have the option of continuing at $7.99 but now on the SD plan, or continuing on HD at $9.99 a month. Given these members have been with us at least 2 years, we expect only slightly elevated churn. Our 2020 US contribution target remains at 40% and we are already at 34%.
In the last remaining major market, China, we have work and uncertainty ahead. We are building relationships, understanding the market, and seeking the conditions we require to provide our service to entertainment lovers there. Our expectations are modest and long?term. We may be able to get started this year and thus deliver on “whole world by end of 2016” or it may take longer. Most of our focus is on the 130 countries we launched on January 6, which are now embracing Netflix as a new entertainment option.
Considering the stock is up about 10% in the after hours, the Netflix story remains intact.
What was the cost of keeping the last FANG momentum "story" alive? A record $276 million in cash burn in the quarter.
And then this:
Free cash flow amounted to ?$276 million in Q4 and ?$921 million for the full year 2015. As a reminder, our investment in originals, particularly owned content, requires more cash upfront relative to licensed content, which will continue to dampen free cash flow. We finished Q4 with debt of $2.4 billion, unchanged from the prior quarter, and with cash & equivalents and short?term investments of $2.3 billion.
Given our expected cash needs, we are likely to raise additional debt in late 2016 or early 2017. We are managing our balance sheet to lower our blended cost of capital over time, while maintaining financial flexibility. Despite being FCF negative as we grow our original content and invest in international, our bonds trade like a BB credit (vs. their single B rating) due, in part, to the long?term growth of Internet TV globally and our low debt to market cap ratio, which provides bond investors with a very thick cushion of protection.
Of course, as everyone knows, the lack of cash flow doesn't matter until it does. As for NFLX bonds trading like a BB credit, thanks for reminding us to check what the repo rate on those is.