KEY POINTS
- SUB METRICS = MIXED BAG: We’ve been refining our tracker to better account for churn, which tripped us up last quarter. Note this is basically the first test of our retooled tracker, so take the below for what it’s worth (all commentary below on y/y basis). Our tracker suggests that 3Q gross adds improved globally, and that churn eased internationally but picked up in the US. Net-net, our tracker suggests that US net adds may have decelerated again in 3Q while international appears to have materially improved. Net sub adds so far in 4Q appear to be improving across both segments vs. the same QTD period last year (more so Int’l than US). But we’re not sure what that means for the 4Q guide since our retooled tracker suggests that mgmt was seeing a notable reacceleration in 3Q int’l net adds when it guided to only marginal improvement off 2Q, which was its biggest miss on its int'l guide since at least 1Q14. That said, mgmt could take a cautious approach to its 4Q guide, especially considering lofty 1H17 consensus net add estimates ahead.
- PROFIT SURGE BIG WIN FOR BULL CASE: NFLX’s planned price increase has no real COGS attached to it, so it should all flow to down to Contribution Profit. NFLX has already guided to a big increase in 3Q16, but the 4Q16 guide could beat consensus estimates by over $100M with the ASP increase fully baked in. Granted, contribution profit hasn’t been central to the story, but a surge to the magnitude that we’re expected could breathe new life into the longer-term bull case since NFLX may be flirting with cash flow profitability by year end. Put another way, it’s a short-term blow to the long-term bear case of the NFLX model being unsustainable. Note that we emphasize short-term since its contractual obligations due over the NTM and 1-3 yrs out are up 30% y/y as of 2Q16, and NFLX historically spends well in excess of its stated obligations.
- SETUP ISN’T WORTH IT: Even if we do see weakness across its sub metrics, the downside may be buoyed by materially improved GAAP contribution margins; especially since sub weakness may already be the expectation given the recent wave of sell-side downgrades. Conversely, if those sub metrics and/or guidance are decent alongside surging profitability, NFLX will show the street that it can drive user growth and take price at the same time, making the 2Q disaster print look like a hiccup. Further, we suspect the stock is leaning more bullish given NFLX's YTD underperformance vs. large cap tech, and hedge fund ownership percentage at its lowest level since 2012 (speculative money already out of the name). That said, we see the 3Q print as a risky short, but not as a long either given potentially soft 3Q US net sub adds and/or a sandbagged 4Q guide; the former would validate an emerging component of the prevailing bear case (i.e. NFLX can't take price). We're staying on the sidelines eyeing an entry point on short side ahead of the 4Q16 print.
Let us know if you have any questions or would like to discuss in more detail.
