Alex Balfour

Netflix Earnings Report Netflix is the world’s largest internet television network or streaming service. They have over 86

million members in more than 190 countries with access to more than 125 million hours of TV shows and movies. Netflix allows its users to watch as much as they want with the ability to stop

and come back as well as no commercial interruptions. On October 17th of this month they reported their quarter three earnings, which is turning heads in quite a positive way. The table below breaks down Netflix’s earnings that were just reported as well as price reactions for the

most recent five quarters to offer a comparison.

Bloomberg and Yahoo Data

Earnings Per Share

or the fourth consecutive quarter Netflix has reported strong earnings per share. With reported earnings of .12 this was a 110.52%

surprise from the estimated .057 (shown in graph to right). This is also the highest EPS Netflix has reported in the last seven quarters with the last high in January of 2015 when they reported .193.

Bloomberg Data

Netflix reported after the market closed, which allows us to see how the stock price reacted from when it closed on the 17th to open on the 18th. Netflix’s stock adjusted close was $99.80 and opened the next day at $116.63.

Netflix’s Stock Price October 2016

From the graph of Netflix’s stock we can clearly see where earnings were reported due to the drastic jump. This is interesting because Netflix has been reporting higher earnings than estimated for the past three quarters but was still having negative

Date Quarter Reported Estimate %Surprise Adjclose Open %PxChg10/17/2016 Q3 0.12 0.057 110.53% 99.80 116.63 19.03%7/18/2016 Q2 0.09 0.027 233.33% 98.81 85.43 -13.13%4/18/2016 Q1 0.06 0.037 62.16% 108.40 99.49 -12.97%1/19/2016 Q4 0.1 0.021 233.33% 107.89 107.74 -0.14%10/14/2015 Q3 0.07 0.076 -7.89% 110.23 103.77 -8.29%

NetflixHistoricalPriceandEarnings

F

reactions to their stock price. Management’s conference call or some other factor must be the reason for this 19.03% change. The stock has continued to climb throughout October all the way up to almost $130, which will be close to the ten month high. As for Q3 from last year’s earnings Netflix fell short of the estimate by -7.89%. This tells me that Netflix is not seasonal and does not correlate over same quarters year by year.

Revenue Growth

Netflix’s revenue grew from 2.105B in Q2 to 2.290B in Q3, which resulted in .33% difference from the expected 2.283B. Revenue has been steadily increasing over time with little to no deviation from this upward trend, which can be seen in the graph below. This revenue growth is the first to be higher than expected in the past seven quarters. We can look back at the revenue reported from the last Q3 which was 1.823B therefore showing the continuous increase in Netflix’s revenue. Netflix went through a process of un-grandfathering subscriptions which has added a level of consistency to the price of subscriptions in the United States. Further, an analyst from Stifel Nicolaus addressed Netflix’s CEO, Reed Hastings, about the possibility of more price increases during Netflix’s conference call. He responded by saying:

“Well look, we've had great couple years at these price points and there's a lot of competition

entering the market. What we're focused on is just how we increase value to the consumer by having

more spectacular shows so that people watch more of Netflix. And over time that will take care of itself, but we don't want to get overconfident just because

we've had a good couple years here.”

Margins

Netflix’s gross margins have been increasing year after year. Quarter 3 reported a gross margin of 31.7%, which is up from quarter 2’s 28%. Netflix’s CFO David Wells says:

“We are starting to see that operating margin grow and the operating profit. We’re growing both

revenue and operating margin. So I think as we are able to reduce our international losses and we’re able to grow both margin and revenue in the US.”

Netflix has been trying to expand internationally for a while now and at first this takes a toll on their earnings and revenues. The problem initially was unfamiliarity of Netflix and unwillingness to pay in undeveloped countries. With this being said, it is impressive how Netflix continues to produce strong margins given the large amounts of money going into international expansion. In the graph below, we can see how the gross margin dropped due to this international expansion, but now it shows how Netflix has rebounded and this expansion is slowly starting to pay off.

Bloomberg Data

When calculating net margins I found that 4.6% was the margin for Q3. These margins have been increasing throughout the year with a Q1 margin of 2.5% and Q2 of 3.3%. These numbers show no sign of deviating from the current upward trend they have shown quarter by quarter. Management also seems very optimistic about all of their margins continuing to grow over the upcoming years.

Bloomberg Data

Management Outlook

One of the main reasons Netflix has been showing such strong numbers even though they have been spending most of their money in international expansion is original content. Management is very excited when it comes to their original movies and shows. This year they have produced 600 hours of original programming and expect 1000 next year. Netflix’s Chief Content Officer Ted Sarandos is very proud of the programming they have produced by saying:

“I'd just add real quick that one of the really encouraging points was our big series that we had

going on in the quarter, Luke Cage, Stranger Things, The Get Down, Narcos, of course, the great

thing is they performed proportionately well globally. So the content is traveling in a way that

we'd hoped.”

Lucky for them these shows are showing as much popularity internationally as they are in the United States. Expanding internationally has some large risks and it showed for Netflix at first with nearly negative 1 billion dollars in FCF. Developed counties seem to be taking well to Netflix but the problem lies within the undeveloped countries who are unwilling to pay. Netflix’s CEO Reed Hastings mentions that Netflix is up to 22 languages but is still far off from where they want to be since YouTube for example is at 50 languages. Another major reason for their growth is through more subscriptions being added, which is mainly due to their expansion. Majority of people in the United States that want Netflix already have it so this is why expanding internationally is so important for them. Management knows they have a long way to go but these profitable quarters they are seeing will boost them to continue on this path of expansion.

Market Reaction

As I mentioned previously Netflix’s stock reacted remarkably well to their earnings report with an increase of 19.03%. The market reacted positively with Netflix but not as drastic of a change of course. The S&P 500 rose by .6% in the morning of October 18th to 2,139.08. The Dow Jones and the NASDAQ also increased by .8% and 1%

respectively. Shown below is the stock price of the S&P 500 over the course of October and we can see the positive reaction it had from the 17th to the 18th, which could be due to earnings announcements such as Netflix.

Bloomberg Data

Conclusion

This report was relatively consistent with what Netflix has produced in the previous quarters but the real surprise came with the stock prices reaction. International expansion, subscriber addition and original content are the main drivers behind this strong numbers. 110.53% surprise on earnings does seem like a high number but compared to earnings from the last three quarters this seems to be the norm for Netflix with previous surprises as high as 233.33%. All in all Netflix is on the rise to dominate the internet television industry globally in the near future. The major costs spent on expansion are finally starting to pay off. I predict there cash flows to take a sharp turn upward towards the positive in the next few years cementing Netflix’s presence in the global arena.

2110212021302140215021602170

10/3/2016

10/5/2016

10/7/2016

10/9/2016

10/11/2016

10/13/2016

10/15/2016

10/17/2016

10/19/2016

10/21/2016

10/23/2016

10/25/2016

10/27/2016

10/29/2016

10/31/2016

S&P500OctoberPrices