Netflix (NFLX 352.25, -48.23, -12.04%) is trading sharply lower today after it reported Q2
results last night. GAAP EPS came in at $0.85, which was above prior guidance
of approximately $0.79. However, it would have been $0.66 excluding an F/X
gain. Revenue rose 40.3% year/year to $3.91 bln, which was slightly below prior
guidance of $3.93 bln. The guidance for Q3 was not great as NFLX expects EPS of
$0.68 and revenue of $3.99 bln, both of which are below market expectations.
In terms of operating margin, it improved to 11.8% in Q2 vs 4.6% in the prior year period but was slightly below prior guidance of 11.9%. Q3 operating margin is expected to be around 10.5%. For the full year, NFLX now expects operating margin to be near the lower end of prior guidance of 10-11% as current F/X rates have pushed NFLX's expectations lower. NFLX continues to expect steady growth in operating margin in 2019 and beyond. One thing to consider is that NFLX has a high amount of international exposure. Operating margin benefits from dollar weakness and under-performs on dollar strength.
Net subscriber additions (streaming) in Q2 came in at +5.15 mln (+0.67 mln in US and +4.47 mln international), which was well below prior guidance of +6.20 mln (+1.20 mln US and 5.00 mln intl) and roughly flat from its prior year performance of +5.20 mln. In terms of guidance for net adds (streaming), the company expects Q3 to come in around +5.00 mln (+0.65 mln in US and +4.35 mln international). As you can see, most of NFLX's subscriber growth is coming from outside the US. NFLX concedes that acquisition growth was slightly lower than projected.
In terms of content, NFLX debuted a sci-fi action series called Lost in Space, which was renewed for another season. In addition, NFLX released the second season of one of its biggest originals 13 Reasons Why, as well as Santa Clarita Diet, A Series of Unfortunate Events, Marvel's Jessica Jones, La Casa de Papel (Money Heist), GLOW, and Marvel's Luke Cage. In original kids programming, Boss Baby: Back in Business became one of its biggest kids series ever.
NFLX also continues to ramp up production of non-English originals. In Q2, its debuted season 2 of 3%, a sci-fi original from Brazil and premiered The Rain, a Danish original thriller which became one of its biggest non-English original productions yet, with viewing all over the world.
Of note, NFLX had the most Emmy nominations of any network. The 112 Netflix nominations include five best series and best limited series nominations and are spread across 40 different scripted and unscripted series, TV movies, limited series, documentaries, talk shows, comedy specials, and series for kids.
On the product front, NFLX is boosting its mobile experience. Last week, it unveiled its "Smart Downloads" feature on Android for members that use offline mode, which is particularly popular in emerging markets. Now, when members finish watching a downloaded episode, it will be automatically deleted and the next episode will be automatically downloaded. Smart Downloads works only when the device is connected to Wi-Fi so cellular data plans won't be used.
On the competitive front, YouTube and Netflix are two leading global (ex-China) internet entertainment services. HBO and Disney are evolving to focus on internet entertainment services. Amazon and Apple are investing in content as part of larger ecosystem subscriptions. Each of these firms has unique content and is striving to find the best creators from around the world. NFLX believes that consumer appetite for great content is broad and that there is room for multiple parties to have attractive offerings. NFLX anticipates more competition from the combined AT&T/Warner Media, from the combined Fox/Disney or Fox/Comcast as well as from international players like Germany's ProSieben and Salto in France.
After a strong report in Q1, NFLX disappointed investors in Q2. Revenue and net subscriber adds came in light and the Q3 guidance was not very good. The stock has been a big mover in 2018, more than doubling on a YTD basis to close above $400 yesterday. Basically, the stock had been priced to perfection so any shortfall in the numbers would lead to a sharp selloff and that's what's happening today. We'll see if they can get back on track in 2H18, but we think investors are going to be more cautious in the near term.
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