Netflix Beats the Street on Subscriber Adds, But Margins Worsen

By Tara Seals July 16, 2015

Netflix surprised investors with a better-than-expected addition of 3.28 million streaming subscribers for the second quarter, translating to revenue that was in line with estimates at $1.65 billion.

The Street rewarded the company, and shares surged more than 10 percent in after-hours action, despite the fact that profits plummeted 63 percent. Overall, Netflix reported a profit of just $26.3 million, or 6 cents a share, down from $71 million, or 16 cents a share, a year earlier.

The eroding profits reflect an ongoing margin problem with the company. Its investment in content acquisition and an ambitious global service expansion are expensive endeavors; for Q2, the launches in Australia and New Zealand took their toll. And going forward, the company still faces even more margin pressure as it expects to be in 200 countries by the end of next year, with Japan, Portugal, Italy and Spain slated to launch in the fall. China and India will follow.

Netflix shares have more than doubled in price in the past year, leading some to believe that the stock is over-valued given the margin concerns. However, some analysts are bullish on the growth opportunities that international growth will eventually bring—and are also excited about the company’s stock split, which went into effect on Wednesday. The split meant that shares actually surged 11 percent to $109 in late trading—before the additional bump from the earnings.

“Netflix has done exceedingly well over the past few years. They have been on a big drive to expand out of the U.S. into South America and Europe,” said Kara Ordway, a senior market analyst at City Index.

She added, “As we go into this 7-1 stock split there are obviously comparisons to Apple, when they made a similar move in 2014. Since that

Image via Shutterstock

split, Apple shares have surged. Consumers have moved into the new age of binge-watching TV. They no longer want to wait week by week for shows that are disturbed by advertising. As Netflix increases its content and continues to increase its budgets for production, this model of subscription is only likely to become more popular with consumers, and therefore forecasts for the stock are all very bullish. Once you open up markets like China and India, the scope becomes even more significant.”

It’s clear that future growth will come from global markets: Netflix added 1.026 million subscribers domestically, but 2.37 million internationally. It had forecast 600,000 net adds domestically and 1.9 million international additions.

But in the letter to shareholders, CEO Reed Hastings noted that despite the slowing U.S. growth and market saturation, the domestic market is a profit center. “We continue to target a 40 percent US contribution margin by 2020, even though we are running ahead of plan given stronger than expected top line performance and lower content and other streaming costs.”

Hastings also said to expect profit worldwide in 2017: “We remain committed to running around break-even globally on a net income basis through 2016, and to then deliver material global profits in 2017 and beyond.”

The company’s Q3 forecast calls for another 1.15 million domestic subscriber additions, and 2.4 million more international additions.

TechZone360 Contributor

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