KEY POINTS
- EXACERBATED SEASONALITY: Mgmt suggested that it recaptured many of the subs that had churned off during the 2016 ungrandfathering scare, which implies that the subs who had cancelled because of the price increase have suddenly seen the light and rejoined. The other more plausible explanation is that our heightened seasonality thesis started a year early, meaning NFLX’s elevated churn in 2Q16 (and we suspect 3Q16) wasn’t just because of the announced price increase, but because the announcement prompted a group of seasonally idle subs to cancel the service since there was no longer a penalty for doing so, and then they came back when the weather turned. The sudden return to y/y growth in US sub adds coinciding with NFLX’s seasonally strong 4Q reinforces this point, especially since US net adds have been in near steady decline for the past 3 years. That said, if those reclaimed subs churned off during NFLX’s seasonally weak (warmer) 2016 quarters, there’s nothing stopping them from doing the same in 2017. Note that only a few percentage points of incremental churn amongst NFLX’s recently ungrandfathered subs could effectively wipe out NFLX’s net adds in those seasonally weaker quarters. See the note below for more detail on our anticipated US sub-add headwinds as well as an explanation of the int'l sub-add headwinds that we're expecting.
- NOT ENOUGH CAPITAL: NFLX could possibly counteract its 2017 sub-add headwinds by considerably ramping up its marketing spend, but new 2017 color from mgmt reinforces our thesis that it will not have the operating budget to do so. NFLX suggested that is expecting $2B in cash burn in 2017 against a current cash balance of $1.7B, so mgmt already has limited wiggle room to begin with before it has to tap the capital markets again in 2017. We estimate that NFLX’s current sub base will provide about $10B in annual revenue (assuming no s/t churn). That is less than what NFLX spent last year in Cash Operating Expenses (ex Marketing), which are expected to increase considerably on the content side given the trajectory of its NTM obligations + original content production, as well on the Tech & Dev + G&A side given rough mgmt guidance for a ~$500M GAAP increase in 2017. Net-net, we estimate that NFLX’s current sub base can’t fund its 2017 Cash Operating Expenses (ex Marketing), so much of its $1.7B in cash is already tied up. In essence, NFLX's ability to ramp up its marketing spend in the event of sub-add pressure is basically dependent on incremental revenues from the new subs that its marketing budget is meant court (yes it is that convoluted).
- ASLEEP AT THE WHEEL: Think about the progression of the story. NFLX had a very nasty 2Q16 that exacerbated fears around the price increase prematurely (ourselves included), then NFLX bounced back on the 3Q16 print largely on the heels of a subdued guide. Mgmt also preemptively sandbagged the 1Q17 guide on the same print. Now on the 4Q print, mgmt blew estimates and guided high for 1Q, so the street is now assuming that NFLX is completely out of the woods from the earlier undgrandfathering scare, while the sub-add outperformance may actually just be seasonal recapture that will likely reverse in 2Q/3Q for the same reason. Meanwhile, consensus sub-add estimates will likely rise for both 2Q & 3Q. Further, the stock is up only 5% on what was optically a blow-out quarter, suggesting that the stock may be on a rope. Not sure we could ask for a better setup on our NFLX short right now.
See note below for supporting analysis behind our thesis. Let us know if you have any questions, or would like a copy of our NFLX 2017 Bear Case deck.
Hesham Shaaban, CFA
Managing Director
@HedgeyeInternet
NFLX | New Best Idea (Short)
01/13/17 03:44 PM EST
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