SUMMARY: We expect the NFLX debate to favor the bears this year given heightened and simultaneous headwinds on sub adds across each of its steaming segments, which we expect to manifest in NFLX’s seasonally weak quarters (2Q & 3Q). We’re putting the short on now despite the preemptively sandbagged 1Q17 sub guide on the 3Q16 print. Reason being is that if NFLX disappoints on guidance, we could miss the 2017 short altogether since the sell-side tends to overreact to whatever happens on the print, meaning consensus estimates would likely rebase considerably lower post print. But if the 1Q guide beats consensus, we can live with the squeeze at ~$133, especially since we’ll likely be vindicated on the 1Q, if not 2Q print. Our int’l tracker currently suggests that 1Q net adds are sharply declining QTD but inline with rebased consensus estimates. That said, the guide could go either way, but not likely to beat by a healthy margin.
The bullets below are a summary of the sub-add headwinds covered during our NFLX 2017 Bear Case call on Dec 6th. We have included some of the slides below, but most of the supporting detail is in the deck. Let us know if you would like a copy of the deck/replay.
KEY POINTS
- US = NO CHURN DETTERENT: There’s no longer a penalty for churning off the service with the removal of grandfathered pricing since those users will no longer lose preferential pricing for doing so. We’re not as concerned about outright churn as we are intermittent churn; as in subs putting their accounts on pause when they’re not using the service as much (e.g. summer). We’re not suggesting that this will happen at any grand scale, but low single-digit churn amongst those ungrandfathered subs (+50% of US subs) could potentially wipe out NFLX’s US net sub adds in its seasonally weak quarters. Note that consensus is expecting US net subs adds to suddenly return to growth next year after persistent y/y declines dating back to 2Q14. We suspect a seasonal decline in total US subs is more likely than US net sub adds suddenly returning to y/y growth in 2017; especially since our survey work suggests that NFLX has already captured most of the low-hanging fruit in the US.
- INT’L = NOWHERE TO EXPAND: While many would assume that a run-rate of 12M-13M int’l net sub adds is the new norm now that NFLX is global, but what we have found is that the trajectory of the its net add growth follows the trajectory of its TAM expansion. Specifically, as the y/y benefit of that TAM expansion starts to wane, so too does the growth rate in its int'l net adds. Further, NFLX’s 2016 ROW launch will likely emerge as a headwind to net subs adds in year 2 given largely unavoidable pressure on both gross adds and churn. First, NFLX tends to capture a bolus of pent-up demand when it first enters a new territory, which naturally isn’t repeated year 2. Second, year 2 of any launch will naturally come with increased churn simply because year 1 doesn’t really have user base to churn off of. That said, the 2016 ROW launch will likely be a drag on net adds for those reasons, and since NFLX doesn't have a country to expand into to offset the ROW post-launch headwind, we suspect that int'l net sub adds will decline on a y/y basis this year (and not just in 1Q).
Let us know if you have any questions or would like to discuss in more detail.
Hesham Shaaban, CFA
Managing Director
@HedgeyeInternet
