Netflix’s Price Hike Stunts Subscriber Growth

Subscriber growth in the fast-growing international markets plunges to a three-year low

N1Netflix Inc. (NASDAQ: NFLX), a U.S.-based provider of on-demand internet streaming media, announced its Q2 FY16 financial results on July 18th, 2016. Headquartered in Los Gatos, California, Netflix engages in the internet delivery of TV shows and movies on various internet-connected screens, such as TVs, digital video players, TV set-top boxes, and mobile devices. The Company operates in three segments: Domestic Streaming, International Streaming, and Domestic DVD. The firm provides its members subscription-based offerings to receive TV shows and movies streaming content, including original series, documentaries, and feature films through a host of internet-connected screens. The company also provides DVDs-by-mail membership services. It serves approximately 75 million members in 190 countries. Read more about Netflix’s financial results below.

Q2 FY16 financial highlights

Netflix’s Q2 FY16 revenue jumped 28% to $2.11 billion as compared to the year-ago quarter. Despite the spurt in sales, Netflix failed in its plans to create the first global, online TV network after a price increase resulted in subscriber growth, especially from the fast-growing international markets, plunging to a three-year low. Netflix added 1.68 million subscribers in Q2 FY16, missing forecasts both in the U.S. and international markets, and bringing the Company’s subscribers’ total to 83.2 million. The international markets now account for 43% of Netflix’s overall subscriber base. On the bright side, Comcast Corp. (NASDAQ: CMCSA) has agreed to offer Netflix on its X1 set-top boxes, which could help it attract more subscribers in the U.S.

Source: Netflix
Source: Netflix

It may be recalled that Netflix faced customer backlash after raising prices in 3Q FY11, when it lost 800,000 U.S. subscribers after splitting its streaming and DVD services, thereby effectively doubling the cost for some customers. Similarly, in Q2 FY16, Netflix faced higher churn and mass cancellations for its services when it raised prices $1 or $2 a month for new customers, and imposed the increase on existing customers. The Company charges $7.99 to $11.99 a month in the U.S. The higher prices would add $470 million in incremental annual revenue for Netflix.

US Streaming: Netflix’s Q2 FY16 net additions were 0.16 million against a forecast of 0.50 million. U.S. revenue rose 18% Y-o-Y to $1,208 million, with domestic ASP growing by 4.5% Y-o-Y. As expected, U.S. contribution margin at 34.3% expanded more moderately as compared to the year-ago period, owing to the timing of content spend. In addition, marketing expenses rose sequentially to support its growing slate of originals and business partnerships. Netflix so far has over 47 million customers in the U.S., exceeding that of any domestic cable network.

International Streaming: Netflix’s Q2 FY16 net additions were 1.52 million compared to forecasts of 2.0 million. The Company is relying more on the international markets to provide most of its new subscribers. Most analysts anticipate Netflix’s overseas customer base will surpass the domestic total in the next couple of years. International revenue jumped 67% to $758 million as compared to $455 million in the year-ago period. Excluding the impact of foreign exchange, international ASP increased 8.7%. However, international contribution margin declined to 11.2% during the reporting quarter.

Domestic DVD: Netflix ended Q2 FY16 with 4.5 million DVD members in the U.S., and a profit contribution of $71 million.

Finally, Netflix ended Q2 FY16 with operating income of $70 million and net income of $41 million. The Company reported an EPS of $0.09 a share, an increase from $0.06 in the year-ago quarter.

International expansion

Netflix introduced its TV services to 130 new markets in January 2016. As part of its international expansion, Netflix has excluded China since it faces a challenging regulatory climate there, apart from cost competition from local players that offer cheaper, domestic content. Netflix also faces intense competition in the U.S., where large media companies are starting to offer more of their shows online themselves, such as Time Warner Inc.’s HBO Now, or through rival outlets like Hulu. To ward off competition, Netflix is creating more local original programming, including shows for Italy, Brazil, and India.

Focus on fresh content

In Q2 FY16, Netflix continued to expand the pace and breadth of original series, films and documentaries released, including the 4th season of “Orange is the New Black” and the second of Adam Sandler’s films “The Do Over”, which, at launch, was the number one most-watched film on Netflix in every territory of the world and remains in the top 10 in many countries, including the U.S. In 2017, Netflix will also be the exclusive home of the new “Star Trek” series from CBS outside the U.S. and Canada, with new episodes to be aired in 188 countries within 24 hours of their North American premiere.

Share of internet traffic

As shown in the diagram below, Netflix’s share of North American Internet traffic was 35% as a result of a more efficient encoding structure.

Source: Netflix
Source: Netflix

 

Outlook for Q3 FY16 and after

In terms of subscriber outlook, Q2 FY16 reflects the fallout from higher prices and competition for viewers from the upcoming Olympics. In Q3 FY16, Netflix expects to add 2.3 million net new customers, including 300,000 in the U.S. and 2.0 million internationally. The company forecasts earnings of $0.05 a share, a drop from $0.07 a year earlier. Netflix plans to top 100 million customers worldwide in 2017. The Company’s programming is expected to be customized accordingly for audiences outside the U.S.; Netflix expects to spend about $6 billion in cash on content in FY16. The Company aims to eventually have 60 million to 90 million customers in the U.S. and boost its share to 88.7 million subscribers outside the U.S. by 2020.

Stock Performance

N4Netflix’s stock stood at $85.84, nosediving 13.13%, at the close on Tuesday, July 19th, 2016, having vacillated between an intraday high of $86.75 and a low of $84.50 during the session. The stock’s trading volume was at 55,567,518 for the day. The Company’s market cap was at $36.63 billion as of Tuesday’s close.

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