Netflix had a great 4th Quarter, but the Street expects more

January 24, 2020

Netflix had a great 4th Quarter, but the Street expects more
I'm Sean Hathaway

Hi, I'm Sean

20 years of finance experience and obsessed with high quality results.

Slowing domestic (US) growth disappoints investors. International positioning is under-appreciated.

Advertising? No. And for good reason. 

Netflix will continue to grow steadily for many years, likely decades.

Stock Price: 

The stock needs a few things to stay on track and go to $500:

  • Cash Flow needs to improve, i.e. 2019 better be “peak negative cash flow” as Reed declared in the earnings call. 
  • Global subscriber growth needs to stay on track, i.e. 28m+ for 2020, and no more net decreases domestically.  
  • Netflix needs another break-out hit along the lines of Stranger Things or better yet their ever elusive Game of Thrones. Could it be The Witcher

To really break-out, like $700+ in next 2-3 years: 

  • New Subs: Need to accelerate past 30m subs per year. 
  • Content: A must-see title in magnitude and zeitgeist of Game of Thrones, would help. Or a globally demanded film in the neighborhood of Star Wars or Avengers, but frankly very tough without existing IP. But it can be done: Titanic, for example. 
  • China: Open for business. 
  • Sports. For the US they likely could grab a significant cohort of non-subscribers with high demand sporting events like Sunday or Monday night football. Or possibly Nascar, which is more congruous to no commercial format. Globally, something like the World cup, cricket or tennis.

Subscriber Growth

Netflix reported Q4 2019 earnings this week, including record revenue of $5.5b and 167m global subscribers. However, US sub growth of 0.5m, disappointed, as it was down from 1.2m in Q4 2018. 

Netflix has penetrated 60-70% of US Broadband households, reaching a point of saturation, and facing headwinds from new streaming competition of Apple and Disney in Q4 and HBO/AT&T and NBC/Peacock coming in 2020. The fact is Investors weigh heavily US performance, because the US is a reasonable indicator of potential growth in foreign markets. 

Why is US Sub-growth slipping? It's getting incrementally harder to acquire each new sub. 

But consider this… 

For every $1 Netflix spends there is an opportunity cost, and it’s not the same opportunity US competitors have. Netflix must choose how to allocate their spending regionally. For example,  say they are hypothetically debating to spend $500m in marketing and content in either the US or International. Maybe that $500m spent in the US gets 400,000 new subscribers, but spend it in EMEA or APAC and it gets you 1,600,000 subs. They should choose the latter, and generate more cash. This analysis is over-simplified, but it’s illustrative. 

As an investor, I’d love to see domestic subs growing more, but on the other hand, I’m glad investment is being made with cash generation and international growth in mind. 

Here’s a bigger theoretical question: Given $500m who can allocate that more efficiently to generate revenue? Apple, Disney, Peacock, Netflix? My bet is on Netflix, because of their global scale and platform; hard to prove, but time will tell. For example, when Netflix spends on a great piece of content, like Stranger Things, not only does that benefit US demand, but subs in Vietnam and France are signing up.  

That all said the more concerning point is that total sub growth in 2019 was 27.8m, about 1m less than 2018. However, it must be noted that year-over-year Netflix increased average global pricing by 5%, which also created a headwind for decreased subs. Netflix will have less pricing power in the US for the next couple of years until this competition shakes out a little.

International 

The international penetration of streaming that Netflix has achieved and will continue is under-appreciated. Disney, Amazon, Apple will figure it out, but it will take years. (I’m more skeptical of Peacock and HBO figuring it out). 

Consider this: Netflix is producing 130 series of local language television in 2020. And local originals were the most popular 2019 titles in many countries, including India, Korea, Japan, Turkey, Thailand, Sweden and the UK. Further in order to scale US and local titles across the platform Netflix is commonly dubbing into nine languages: French, Italian, German, Turkish, Polish, Japanese, Castilian Spanish, Latin American Spanish and Brazilian Portuguese, and it offers subtitles in 27 languages. WHAT!? Subtitles in 27 languages is not an easy feat when you consider not only the language/artistic effort, but the technology and infrastructure required behind the scenes to make that work. 

When I watched the Newsroom on Apple (a really great show by the way) the English Audio and subtitles were screwed up on parts. 

Advertising 

Every quarter it seems Netflix Management reiterates they don’t expect to start advertising, but this quarter Reed offered some enlightening - arguably intuitive - thoughts. Advertising is not easy money. Amazon, Facebook and Google have become the most powerful effective advertising machines in the world, partly through their insidious collection and utilization of user data. With the exception of viewing, Netflix does not collect user-data. These big 3 are getting better every day and Netflix would have to compete with them. Obviously, Netflix could attract some advertising dollars, from linear TV for example, but would it really prove profitable. And at what expense? 

Netflix benefits from not being embroiled in user data scandals and government inquiries. So in short: (1) Contrary to popular belief it is not easy to monetize from advertising and (2) because there is no personal data collection - save viewing - Netflix is a more comfortable and “safe” place for users. 

Conclusion

In the long-term, investors’ demands are simple: more subscribers, revenue, profitability (check, check, check) and particularly in the case of Netflix, more positive cash flow. We’ll see on the last one. 

Netflix’s international growth opportunity is tremendous and they will continue to grow significantly for years to come. The professionals that work there are extremely smart and determined, and so will continue to solve the puzzle of US subscriber growth. So while US growth has slowed, it will not stop.

About 10 years ago Netflix started “streaming” and since then we are seeing a monumental historical shift in TV viewing from the cable advertisement supported model to on-demand streaming. This shift in viewing is happening globally and will continue for many years. Netflix is on the frontlines and leading the charge Content-wise and technologically.  

Netflix will not stop growing Revenue any time in the next two decades, probably more. In thinking about the stock price growing it’s not a matter of if, but simply when. 

Sean Hathaway is an Investment Advisor and Manager at HathawayFinancial.com


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Netflix Q4 2018 earnings on Jan 23