While today's drift lower in NFLX shares was widely attributed to AMZN's more aggressive expansion into the streaming video space, some wondered if there was more to it. Moments ago, the answer was revealed and it was a resounding yes.
The reason why NFLX stock is crashing in the afterhours session is (mostly) because of the company's guidance of its widely followed international expansion. Here, instead of guiding to or above the consensus estimate of 3.45 million subs, Netflix disappointed dramatically and now anticipates only 2 million international streaming net adds, down from both the 2.37 mm a year ago, and certainly from the 4.51mm net adds last quarter.
While domestic adds were of lower significance as the growth rate there has already dropped substantially, NFLX reported 2.23MM net adds in Q2, above the 1.82MM expected, but its domestic Q2 guidance was also lousy, and the company now sees just 500,000 net adds in Q2.
This is how Reed Hastings explained the sudden slowdown in growth, as well as the plateauing in margins:
In the US, our Q2 net adds forecast of 0.5 million is inline with prior years (0.5, 0.6, 0.6, and 0.9 million from 20122015), taking into account a modest impact from the beginning of ungrandfathering.
Our international forecast for fewer net adds than prior year is due to a tough comparison against the Australia/New Zealand launch. The ANZ growth spike in Q2 last year resulted in international Q2 net adds more than doubling year over year (from 1.12 million to 2.37 million). While ANZ is growing steadily this Q2, it is less than the launch spike last year. ExANZ, international net adds would be forecast up this quarter. International net adds are down sequentially both due to standard seasonality and our launch in 130 countries at very beginning of Q1 (so Q1 captured the initial surge of signups).
In the US, we are forecasting flat Y/Y contribution margin in Q2, due to a large slate of content releases and associated marketing. We expect strong y/y margin growth to resume in Q3 and we remain on track to achieve our 40% US contribution margin target by 2020.
We expect Q2 international contribution loss to improve sequentially primarily due to recent favorable currency movements. We anticipate that international contribution losses in the second half of 2016 will be similar to the first half, as ongoing investments offset improved profitability in our more mature markets.
Bottom line: growth is slowing. Finally, on the holy grail, China, Netflix had nothing reassuring:
On China, we are continuing discussions but have no material update on our approach or timing. Whatever we do will have only a modest financial effect in the near term.
NFLX also gave details on its "ungrandfathering" process:
With respect to ungrandfathering, currently, more than half of our US members pay only $7.99 or $8.99 for our $9.99 HD 2screen plan. We will phase out this grandfathering gradually over the remainder of 2016, with our longesttenured members getting the longest benefit. To reinforce brand trust, we won’t change anyone’s price without their acknowledgement of the new price in their member experience, where they will see a dialogue box about their options. Members can choose our $7.99 SD 1screen plan, our $9.99 HD 2screen plan or our $11.99 UHD 4screen plan. We are rolling this out slowly over the year, rather than mostly in May, so we can learn as we go. Most of our grandfathered members are in the US, but we’ll take the same approach internationally.
The company also discussed the increasingly sensitive topic of competition:
If you think about your last 30 days, and analyze the evenings you did not watch Netflix, you can understand how broad our competition really is. Whether you played video games, surfed the web, watched a DVD, TVOD, or linear TV, wandered through YouTube, read a book, streamed Hulu or Amazon, or pirated content (hopefully not), you can see the market for relaxation time and disposable income is huge, and we are but a little boat in a vast sea. For example, while we’ve grown from zero to 47 million members in the USA, HBO has also grown, which shows how large the entertainment market is. We earn a tiny fraction of consumers’ time and money, and have lots of opportunity ahead to win more of your evenings away from all those other activities if we can keep improving.
NFLX also expects more spending:
The increase in ARPU will allow us to invest more in content next year, and we are taking up our expected spend from about $5B in 2016 to over $6B on a P&L basis in 2017.
Which brings us to our favorite topic: cash burn. Here is NFLX's explanation:
At the end of Q1, we had cash and equivalents totaling $2.1 billion. In Q1, free cash flow was $261 million, compared with $276 million in Q4 ‘15. As we have written in the past, our investment in original programming (particularly owned content) is more cash intensive upfront, resulting in a timing-driven gap between net income and free cash flow. We currently have $2.4 billion of long term debt. With our low debt to enterprise value of 5%, our plan is to raise additional capital through the high yield market later in 2016 or in early 2017.
Expect that debt to grow, because as the chart below shows, NFLX burned through over $1 billion in cash in the past 12 months and has increasingly less growth to show for it.
For a long time investors let if go. However, judging by the stock's reaction after hours...
... they are no longer quite so generous.