Netflix Falls After Earnings: Buying Opportunity?
What’s Going On With Netflix
Netflix reported strong growth for the second quarter of 2014.
However, earnings guidance for the third quarter came in
materially below expectations, as the company is planning to
accelerate investments for international expansion.
The stock was falling by 5.3% on Tuesday, as investors reacted
with pessimism to the news.
However, management seems to be doing the right thing by
focusing on long-term growth opportunities as opposed to short-
term profit margins.
Is the dip in Netflix a buying opportunity for investors?
Healthy Subscriber Growth
Netflix added 1.69 million new members during the second
quarter, an accelerated growth rate versus 1.24 million new
members in the second quarter of 2013.
The company added 0.57 million subscribers in the U.S. and
1.12 million members in international markets. Both the U.S. and
international markets came in above guidance.
Netflix ended the quarter with 36.24 million U.S. members and
13.8 million international members. This brings the total
membership count to more than 50 million.
Management is forecasting 3.69 million new members during
the third quarter.
Netflix produced $1.34 billion in revenue during the quarter, a
25% increase versus the same quarter in the prior year. The
number was above analysts’ forecast of $1.33 billion on average.
Domestic sales increased 25% versus the same quarter in the
prior year, representing approximately 73% of total streaming
revenues during the quarter.
International revenue jumped by a whopping 85%, generating
27% of total streaming revenue during the period versus 20% in
the second quarter of 2013.
Revenue in the DVD segment fell 16%.
Total contribution margin jumped to 18.5% versus 10.2% in the
second quarter of 2013.
Contribution margin in the U.S. came in at 27.1% versus 22.5%
in the prior year quarter.
Contribution loss in international markets was materially
reduced, from a loss of 39.7% to a much smaller negative margin
Management expects total contribution margin to decline to
16.6% in the third quarter due to increased spending for
Earnings per share came in at $1.15 during the quarter, a big
increase of 135% versus $0.49 per share in the same quarter of
2013. The number was marginally below analysts’ expectations of
$0.16 on average for the quarter.
For the third quarter of 2014 management is forecasting
earnings per share of $0.89, considerably below forecasts of
$1.06 on average for the quarter.
Lower-than-expected guidance seems to be the main reason for
disappointment among investors.
Accelerating International Expansion
Management is very optimistic regarding international demand:
“What we’ve seen really is just tremendous adoption of on-
demand viewing consumers around the world, whether it’s
Argentina, Brazil, Finland, the U.K. -- it’s been really quite
In September the company will be launching the service in
Germany, France, Austria, Switzerland, Belgium, and
Luxembourg. This will significantly expand Netflix’s total
addressable market to over 180 million broadband households, or
double the number of current U.S. broadband households.
International expansion is expensive, but it seems to be really
worth the effort in terms of growth opportunities.
Strong Pricing Power
“In May, we raised prices modestly in most of our markets for new
members on our two screens at-a-time HD plan, and introduced a
one screen at-a-time, standard definition plan across our markets.
Our two screen HD plan continues to be the most popular plan
choice for new members. We expect ARPU [Average Revenue Per
User] to rise slowly as members at the new prices grow as a
percentage of total membership. There was minimal impact on
membership growth from this price change.”
Source: Netflix letter to shareholders, July 21, 2014.
The second season of Orange Is the New Black has been the
most watched series in every Netflix territory during its first
Netflix original series and documentaries received 31 Emmy
nominations -- more than double the 14 nominations the company
received in its first year of releasing original programming.
The company is putting more focus on international markets
when it comes to original productions in order to better reflect the
increasingly global nature of the Netflix service.
Accelerating international expansion will have a negative impact
on profit margins in the medium term.
However, considering how encouraging demand has been in
international markets, Netflix seems to be clearly making a smart
strategic move by betting on global growth.
The business is still generating impressive growth rates, both in
the U.S. and abroad. Operating profitability is also moving in the
right direction when leaving aside investments for growth.
Short-term weakness in Netflix may create a buying opportunity
for long-term investors.
The $2.2 trillion war for your living room
can be a huge opportunity for investors. Do
you know how to profit from it?