Netflix Earnings Soar 135%, But Miss; Subscriber Gains, Outlook Are Strong

Investor's Business Daily

Netflix (NFLX) earnings more than doubled in Q2, though that missed estimates by a penny. But subscriber growth beat, as the online video streaming giant set a September launch for six new European markets.

The Los Gatos, Calif.-based company expects Q3 profit of 89 cents, below consensus estimates of $1.06, mainly on costs for expanding into Germany, France, Austria, Switzerland, Belgium and Luxembourg. Wall Street had expected a Q4 launch.

Netflix didn't give a revenue target for Q3, as usual. Top-line growth will grow 25% in the September quarter, analysts predict.

Netflix said it earned $1.15 a share in the June quarter, up 134% from a year earlier, but just below views for $1.16. It was the sixth straight quarter of triple-digit growth.

Sales rose 25% to $1.34 billion, a hair above estimates for $1.334 billion and the best gain in 10 quarters.

Netflix's stock edged up about 1% in after-hours trading Monday. During the regular session, shares closed nearly 2% higher to 451.95. The stock has gained 23% in 2014, hitting a record high of 475.87 on July 2.

After posting triple-digit EPS growth the last five quarters, Netflix's profit growth had been expected to slow as a result of its international expansion.

Overseas Isn't The New Black

"This launch into markets with over 60 million broadband households will significantly increase our European presence and raise our current international addressable market to over 180 million broadband households, or two times the number of current U.S. broadband households," said CEO Reed Hastings and CFO David Wells in a letter to shareholders.

Netflix currently operates in the U.K., Ireland, the Netherlands and Scandinavia, as well as Canada and parts of Latin America. While existing overseas markets may turn profitable by year-end, the international segment will remain in the red because of its expansion.

"We expect a consolidated contribution loss of $42 million for the international segment in Q3," Hastings and Wells wrote. "Even after our upcoming expansion in Europe, we'll only address about one-third of current global broadband households, providing a great opportunity to build on our international success beyond 2014.

In Q2, Netflix added 1.152 million paid international subscribers, up from 683,000 a year earlier, beating estimates. It added 708,000 paid U.S. customers, about the same as a year earlier.

As of June 30, Netflix had 35.1 million online subscribers in the U.S. and 12.9 million overseas.

Big User Growth In Q3In Q3, Netflix forecast 1.33 million U.S. subscriber additions and 2.36 million overseas, well ahead of the consensus for a total of 2.9 million. Analysts had expected 1.6 million foreign user adds.

Q2 is typically Netflix's seasonally softest quarter for new subscribers, as is the case with pay-TV companies like Comcast (CMCSA), which reports Tuesday morning.

In May, Netflix raised prices for new U.S. members by $1 to $8.99 monthly. Existing Netflix subscribers are exempt for two years, so analysts don't expect a material impact to revenue until 2016. It also raised prices by a similar amount overseas.

Original Content Key

Netflix has stepped up investments in original content, such as the show "House of Cards," lessening its emphasis on movies and older TV shows. Season two of "Orange Is the New Black" started in June, possibly boosting Q2 subscriber adds, analysts say.

Q3 and Q4 are expected to benefit from season two of "Hemlock Grove," two new series — "Marco Polo" and "BoJack Horseman" — and up to three kids series.

Netflix's ability to create hits remains key, analysts say, as rivals Amazon.com (AMZN), Hulu and cable networks also shift investments to original content.

Aside from programming costs, expected to hit $3 billion in 2014, Netflix's overseas expansion has been a focus of analysts.

In Europe, Netflix faces competition from Amazon in the U.K. as well as pay-TV incumbents BSkyB, Vivendi and 21st Century Fox (FOXA). Europe's incumbents have exclusive distribution agreements for U.S. content, including Hollywood films, which could impact Netflix's growth, analysts say.

Netflix reportedly has been in talks with Germany's Deutsche Telekom. The phone giant may agree to offer Netflix's streaming service to its broadband customers. Deutsche Telekom has 12 million broadband users, about a 40% share, in Germany.

In the U.K., Netflix has a distribution pact with Liberty Global-controlled Virgin Media. The largest U.S. cable TV operators, though, have yet to offer a Netflix app on their set-top boxes.

Netflix Vs. Comcast

Netflix opposes the merger of Comcast and Time Warner Cable (TWC), the two largest cable TV firms. Federal regulators are reviewing that deal.

Netflix in February agreed to pay Comcast for ensuring smooth connections to its cable network, a move to improve customers' download speeds. Netflix, though, has asked the Federal Communications Commission to take a closer look at such network "peering" arrangements. Apple (AAPL) reportedly has also been in talks with Comcast over a streaming video service it's said to be building.

Aside from pay-TV mergers, other media consolidation could impact Netflix, analysts say. Time Warner (TWX), which owns HBO, last week rebuffed a takeover offer by Rupert Murdoch-controlled 21st Century Fox. HBO has close cable TV ties.

Netflix's legacy DVD-by-mail business continues to decline.

In Q2, Netflix said it lost 342,000 DVD customers, in line with estimates. It ended Q2 with 6.2 million paid DVD subscribers, down from 7.4 million a year earlier.

Netflix has been encouraging members to switch to its streaming video service and has quit advertising and promoting its DVD business, which is still profitable.

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