KEY POINTS
- 2Q16 = JUST AWFUL: Both the print and our long call into it. We bought NFLX as trade on expected upside to int’l net sub adds for both the 2Q print/3Q guide. NFLX reported int’l net adds of 1.54M (-36% y/y decline) vs. consensus of 2.1M and issued 3Q guidance of 2M vs. our expectation of 3.5M. US was much worse, with net adds at historical lows of 160K and 300K in the 2Q print/3Q guide, respectively. Mgmt suggested its gross adds were inline with its expectations, but heighted churn preempting the price increases from the ungrandfathering of its plans led to the shortfall vs. its expectations. Regardless of the reason, its int’l net subs adds are a big concern given that NFLX hadn’t annualized past many of its 2015 country launches, and it just launched to ROW in 1Q16. The fact that net adds are down on a y/y basis despite these tailwinds casts new doubt on the longer-term int’l story.
- DEMAND = ELASTIC? We clearly underestimated the magnitude of churn in our two trackers this quarter; largely because we didn’t think a $1-$2 increase in the monthly rate would be a big deal for most of its subs. The sub adds miss vs. guidance was the worst in NFLX’s reported history (both US and int’l on a % basis); suggesting mgmt was really caught off guard as well. It’s too early to tell if churn will become a prolonged issue since over half of NFLX domestic subs are in grandfathered plans, and NFLX will be staggering the price increases. But the 2Q16 churn issue casts new doubt over one of NFLX’s assumed levers to cover its longer-term content costs; demand may be more elastic than many of us had assumed. Granted, we could be overreacting to the print, but given the backlash to such a relatively small monthly rate increase, we have to question NFLX’s pricing power.
- THESIS REFRESH: The first two bullets suggest that NFLX may have a shorter runway on both int’l growth and its ability to take price down the road. In the context of our thesis, it appears even less likely that NFLX’s model will survive in its current form, and more importantly, that the street will actually figure that out over the 2016-2017 period following its ROW launch. NFLX's mounting contractual obligations aren't a secret; if int'l user growth sputters out further despite its ROW launch, the specifics of its content costs will likely receive more attention (first note below) as the street realizes that int'l can't compensate for waning US demand (second note). We're actually shocked that the stock isn’t down more pre-market and that we haven't seen any downgrades on one of NFLX’s worst prints in recent memory. That basically suggests that the street still has hope and/or is in denial about NFLX’s longer-term prospects, which also means that we may get another shot on the short side this year.
See the notes below for supporting detail around our thesis. Let us know if you have any questions, or would like to discuss further.
Hesham Shaaban, CFA
Managing Director
@HedgeyeInternet
NFLX | Breaking Down Content Costs
05/26/16 08:14 AM EDT
[click here]
NFLX | Good vs. Bad (US User Survey)
06/09/16 10:41 AM EDT
[click here]
