EUR 850.00 For Business Accounts Only

Morningstar | Netflix Posts Weak 2Q Sub Growth; Marginal U.S. Subs Will Continue to Be Harder to Add

Netflix posted another weak second quarter as subscriber growth came well below guidance and our expectations. Despite the subscriber miss, revenue came in line with our projection. The free cash flow loss for the quarter hit $594 million, up from a loss of $559 million a year ago. Management maintained its 2019 free cash flow loss target of $3.5 billion and continues to insist that the cash burn will “inflect” in 2020. We are retaining our narrow moat rating and our fair value estimate of $135.

Revenue of $4.9 billion came in line with our estimate and guidance. Netflix posted much weaker-than-expected subscriber growth in the international segment (2.8 million net adds versus guidance of 4.7 million) and in the U.S. (a loss of 0.1 million subscribers versus guidance of 0.3 million net adds). The losses in the U.S. reinforces our belief that adding the marginal subscriber will become increasingly hard in the U.S. for Netflix due to market saturation and to competition, particularly after Disney+ launches in November at $6.99 per month. Despite the miss, the streaming subscriber base for Netflix continues to expand, ending the quarter with more than 152 million global paid subscribers, up from 124 million a year ago.

Domestic streaming revenue of $2.3 billion was slightly ahead of our estimate and monthly revenue per paid U.S. member came in at $12.74, up 12% year over year. The growth in monthly revenue is due largely to the recent price increases which have been phased in completely in the U.S. The combination of the net sub losses and large increase does imply some possible price sensitivity for more marginal subscribers with a less price sensitive core user base. However, we believe increased competition and lower priced plans may test the level of price sensitivity for these core users over the next few years.

For the international streaming segment, revenue of $2.5 billion matched our estimate as monthly revenue per paid member came in at $9.43, down 3% year over year without currency adjustments. Total segment contribution margin of 26.7% improved by 330 basis points year over year, leading to an operating margin of 14.3%, up 250 basis points versus the same period last year due in part to lower relative marketing spend. Despite the strong operating margin improvement, management held fast to its guidance of 13% operating margin for 2019, implying increased marketing spending in the second half of the year.

While management blamed the net subscriber losses in the U.S. on a weak content slate, but we believe that higher pricing also played a role. As we have discussed before, Netflix has conditioned its users to expect more original content every quarter. So, when the content slate is weak or unknown, the ability to drive the marginal subscriber to join or to renew becomes harder especially as the price increases. Additionally, we expect the loss of the more popular third-party library content will exacerbate this difficultly. Both executives from AT&T and NBCUniversal have stated that their firm’s most popular content including Friends (AT&T) and The Office (NBCU) will be taken off Netflix and placed on each firm’s respective SVOD offering. Disney has already done this with its 2019 movie slate in anticipation of the launch of Disney+ in November. In response, we expect that Netflix need to keep its content spend elevated and continue to increase its marketing spending to help with discovery.