Netflix,
Q1 2019 - Results
April, 18 2019
1. PREVIOUS ANALYSES
Before reading the results, I’m going to read my previous analysis.
2. RESULTS
OK, It’s done.
Let’s now read the first quarter results that the company announced on Tuesday. It’s only 12 pages long.
Let’s take a look at the positives and the negatives on this letter.
3. POSITIVES
3.1. Subscriber count is up
Netflix is still increasing its number of paid subscribers. In a big way.
As expected, their subscribers growth in the U.S., its most mature market, is slowing down while the international market is still full steam ahead.
The paid net adds (the number of new subscribers minus the number of subscribers that drop the service) was 9,6M!!!, representing a new record and the company is confident it will add 5M new subscribers in Q2, reaching a 14,6M net adds for the half-year, which is another record. These are impressive numbers.
3.2. Pricing Power
One very important metric when analysing a subscription based business is its ARPU (average revenue per user).
This tells us whether the company has pricing power or not.
Recently, the company has been raising the price of its subscription around the world. It says that they’re experiencing some modest short-term churn (people abandoning the service), but they still don’t give us this figure.
As we can see by what the company tells us, they still have pricing power. Although the ARPU has decreased 2%, this was due to currency fluctuations. On a constant currency basis, the ARPU has improved 3% yoy and 2% since last quarter.
The average monthly fee is now around $10 and there are people saying that Netflix is underpricing its product in order to grow faster.
Average Monthly Fee
This is similar to the “Land and Expand” model used in the SaaS businesses. They underprice their product in order to get to people’s homes and then when people are accustomed to it, they charge them more. The biggest difference is that this is a business with low switching costs. People can just end their subscription and turn to a different content provider.
3.3. Revenue is up
Netflix is still a massive growth story. Its revenue has gone up 22,2% from a year ago (28% on a constant currency basis), and they are expecting it to go up 26% on the next quarter.
3.4. Great content
They’ve been releasing great content like the new Attenborough series called “Our Planet” and they plan to go on like this for the rest of the year with success stories like “Stranger Things”, “La Casa de Papel” (aka Money Heist) and big names as Martin Scorsese, Guillermo del Toro, Steven Soderbergh and many others.
4. NEGATIVES
4.1. EBIT Margin is down
The operating margin was 10,2%, down from 12,1% a year ago. The company was guiding for a worst operating margin but now says that they’ve delayed some of the expenses to the next quarters, so we might be seeing increased pressure on the operating margin for the rest of the year.
4.2. Free Cash Flow is still negative
The company is still spending huge amounts of cash on content creation. On the first quarter they’ve spent almost $3B.
And because of this, the FCF was -$440M. Like I said on my first analysis, whenever they take their foot of the gas, they will be extremely cash generative. The thing is, when will that be?
The company is expecting its 2019 FCF to be approximately -$3,5B, while in 2018 it was -$2.85.
4.3. Higher effective tax rate
The company says its effective tax rate will go up in 2019.
4.4. Interest expense is up
The interest expense is up by almost 70% due to a higher level of debt from one year ago. ($6,5B vs $10,3B)
4.5. Competition
There isn’t a lot of change from what I’ve written on my previous analysis. The big boys are coming, especially Disney and its Disney+ streaming service.
I thought this chart taken from the company presentation was quite interesting. What Netflix is saying is that it doesn’t fear competition because there is room for a couple more players. Their total streaming hours in the U.S. on TV still represents only 10% of total TV usage.
Disney will price its subscription at $7 per month or $70 for 12 months (which works out to around $5,83 per month) and as we’ve previously seen, Netflix average price is now $10, so it will be interesting to see this price war unfold.
4.6. Valuation is still sky high
With Netflix, traditional ratios don’t work very well.
Usually when I’m analysing tech companies, especially subscription based ones, FCF is the ratio I prefer to use because the high amortization charges on the Income Statement usually depress earnings.
But here, because of all the spending in content, the FCF is still negative. So for now, and until I figure out how much cash the company will be spending on content creation when it becomes mature, so I can be able to project a normalized FCF, I’ll be looking at the PE ratio.
If we extrapolate this quarter’s net income to the following quarters, we get a PE of 110! Whether the net income is depressed because the company is underpricing its product or not, I think we can all agree this is TOO HIGH for a business with strong competition coming on board.
5. OVERVIEW & CONCLUSION
5.1. OVERVIEW
Netflix is still doing exactly what it should masterfully: Grow its content and its subscriber base around the world before anyone else.
Although I don’t think Netflix will be eaten by Disney+ due to its huge content library and first mover advantage, I think it won’t be able to take the foot off the gas that easily nor to raise prices when it wants.
Yes, one could argue that Netflix is underpricing its product and when it finally charges a “normal” fee ($20 or $30 per month) it will become incredibly profitable. That is true, but the issue here is that Netflix is dependent on one product alone while Disney and Amazon (and Apple and Youtube) have other profitable businesses that can fund their video subscription businesses while charging less than Netflix for a long long time.
I stand my ground. With low visibility into what will happen in the future, I prefer not to swing.
“You don’t have to swing at everything – you can wait for your pitch.” – Warren E. Buffett
5.2. CONCLUSION
This section will be available to paying subscribers in 2019 when we launch the Portfolios.
Don’t forget to check our other analyses.
If you want more, join us at our new:
6. DISCLAIMER
The material contained on this web-page is intended for informational purposes only and is neither an offer nor a recommendation to buy or sell any security. We disclaim any liability for loss, damage, cost or other expense which you might incur as a result of any information provided on this website. Always consult with a registered investment advisor or licensed stockbroker before investing. Please read All in Stock full Disclaimer.