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Takeaway: The good is that the wheels aren’t falling off the yet; the bad is that its model may have taken a fundamental turn for the worse.


  1. THE GOOD: NFLX put a lot of concerns to bed by producing a strong reacceleration in net sub additions in both the US and Int’l markets and guiding ahead of the street for both segments in 4Q.  Int’l net adds reaccelerated from negative to positive growth in 3Q, and sub acquisition cost decelerated on a y/y basis despite a considerable acceleration in marketing spend.  The bigger surprise was the US, where the decline in net sub adds moderated despite 75% of its grandfathered US accounts stepping into a price increase during the quarter.  Note that over 50% of its US accounts were in a grandfathered plan, so the fact that trends didn’t deteriorate suggests NFLX does currently have pricing power, even if it was just a $1-$2 increase.  NFLX also produced a notable acceleration in GAAP contribution profit on the heels of that price increase, and also guided to a notable beat for 4Q. 
  2. THE BAD: Those US net adds cost a lot.  US Marketing expense increased 45% y/y (vs. 18% in 2Q), translating to sub acquisition costs (SAC) up over 200% on y/y basis (comparable to 2Q).  For context, US ARPU and SAC were $112 and $88, respectively, on a TTM average basis, so NFLX could be eventually be walking into a situation where it could cost more to acquire its subs than the revenue it earns from them.  Conversely, some percentage of that marketing spend may be geared toward sub retention rather than acquisition, which is a scarier omen since marketing may remain a considerable component of its longer-term operating model.  Also, it appears that its ASP increase was purely a defensive move.  NFLX Cash COGS (our metric) accelerated to the point where it all but wiped out its revenue, which took us by surprise since cash COGS growth accelerated to nearly 50% y/y vs. the low 30% range in 1H.  Given that NFLX saw another $1B step-up in its content obligations, coupled with the fact that its 3Q operating cash burn was ~25% of its 2Q cash balance, we see its upcoming debt raise as a short-term fix to what is a growing problem (see note below for context).
  3. NET-NET: Near-term trends look a lot better than subdued consensus estimates into the print, particularly in the US given the headwinds facing the segment in 3Q.  NFLX's fundamental prospects took a turn for the worse this quarter, but we can't play that part of the story unless we see expect corresponding near-term pressure on its sub metrics.  We were originally targeting an entry point on the short side ahead of the 4Q print as play on 1H17 net adds, but mgmt surprisingly called out 1Q consensus estimates during yesterday’s call as being lofty, so we need to monitor consensus estimates from here to see if we still have a short catalyst heading into 4Q.  If not, we may entertain the other side of the trade depending how our tracker trends from here.  

NFLX | Breaking Down Content Costs
05/26/16 08:14 AM EDT
[click here

NFLX | Good vs. Bad (3Q16) - NFLX   Cash Model 3Q16

Let us know if you have any questions or would like to discuss in more detail.

Hesham Shaaban, CFA
Managing Director