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Morningstar | Netflix Continues to Burn Cash; 2Q Subscriber Guidance Weak

Netflix started 2019 with stronger-than-expected subscriber growth as the firm continues to benefit from global expansion. Despite the subscriber beat, revenue came in line with our projection. The free cash flow loss for the quarter hit $460 million, up sharply from a loss of $287 million a year ago. Management raised its 2019 free cash flow loss target to $3.5 billion, up from the previous target of $3 billion. We retain our narrow moat rating and fair value estimate of $135.

Revenue of $4.5 billion is in line with our estimate and consensus. Netflix posted stronger-than-expected subscriber growth in the international segment (7.9 million net adds versus guidance of 7.3 million) and in the U.S. (1.7 million net adds versus guidance of 1.6 million). Netflix continues to expand its streaming base, ending the quarter with just under 149 million global paid subscribers, up from 119 million a year ago. Despite strong growth in quarter, management provided very weak subscriber guidance for the second quarter of 0.3 million net adds in the U.S. and 4.7 million internationally. We note the U.S. guidance implies the firm will post its second-lowest net add quarter since the start of 2012. This guidance reinforces our belief that adding the marginal subscriber will become increasingly hard in the U.S. for Netflix due in part to competition, particularly after Disney+ launches in November at $6.99 per month.

Domestic streaming revenue of $2.1 billion was in line with our estimate and monthly revenue per paid U.S. member came in at $11.64, up 4% year over year. For international streaming, revenue of $2.3 billion matched our estimate as monthly revenue per paid member came in at $9.31, down 5% year over year without foreign exchange adjustments. The segment contribution margin of 22.9% fell by 50 basis points year over year, leading to an operating margin of 10.2%, down 190 basis points versus the same period last year due in part to increased R&D and marketing spending.

One quarter into 2019, management has already backed off its previous assertion that 2019 free cash flow loss will be roughly in line with the 2018 loss of $3 billion. Management blamed the higher guidance of $3.5 billion to the new higher tax structure and real estate costs. Management continues to point to 2020 as an "inflection point" for the cash burn, but we expect stronger competition in 2020 and beyond for the firm as Disney, WarnerMedia, Apple, and NBCUniversal all plan to launch their respective SVOD services in late 2019 and 2020. Disney has already fired off a warning shot with its low pricing for Disney+ and its willingness to lose money for at least the first four years. Disney also committed to making the new service the exclusive home of its future family-orientated films as well as the home for its library once its current deals expire. As we noted in our recent Ad-Hoc, "Netflix Needs to Chill: The Director's Cut," these launches imply that Netflix may need to keep its content spend elevated to stave off competition from companies with deep libraries and/or multiple sources of revenue.