Despite demonstrating mediocre results in Q2, Netflix proved to be an attractive investment choice again as it outperformed all estimates of the Wall Street's analysts.
This year has been "weird", say the analysts referring to Netflix's (NASDAQ: NFLX) performance. After failing to meet the targets last quarter when the company faced the lowest number of new subscribers in the last 3 years, yesterday's Q3 results announcement sent NFLX shares soaring 20% in after-hours trading.
This quarter shows that the plans of Netflix's CEO Reed Hastings to expand Netflix audience in the markets outside the U.S. have finally worked out. According to the report, 3.2 million new international subscribers have joined Netflix's audience this quarter, as compared to 2 million subscribers predicted by the analysts in July. In total, the company welcomed 3.57 million new subscribers including those of the biggest American market, bringing Netflix's total paid user base to whopping 83 million subscribers.
However, the domestic subscriber growth did not significantly improve this quarter. The reason for that is "un-grandfathering" of 75% of subscribers who paid the lower prices for their subscriptions, says the company. As a logical result of this "un-grandfathering", Netflix is enjoying a fast growth in the average revenue per user that will continue for the next few quarters until the process is completed. Next to that, the company announced the profits to be at $51.5 million (12 cents per share), which is a big difference from last year's $29.4 million. On the news of the Q3 results, the company's shares jumped 20% to $119s in after-hours yesterday. International contribution loss was at $69 million this quarter, outperforming July's forecast of $95 million, reports The Motley Fool.
According to the Wall Street Journal, adding more subscribers is not only a way to impress investors but also a prerequisite for Netflix as a company producing highly expensive original content for the audience that is always hungry for new shows. In the yesterday's letter to the shareholders, Netflix emphasized the role of the original content in the rapid growth of the number of paid subscribers. One of the gems of Netflix's original shows this quarter was "Stranger Things" starring Winona Ryder:
"We kicked off Q3 with the release of Stranger Things on July 15 to both critical and audience acclaim. This nostalgic, supernatural thriller proved to be the blockbuster of the summer and is the kind of broad appeal, cross demographic, and cross border sensation that we hope will distinguish Netflix original content. Stranger Things is also notable as it is produced and owned by Netflix, which provides us with more attractive economics and greater business and creative control," the company wrote in a letter.
However, after the proven success of Netflix's original content, the audience is only asking for more. In the letter, the company announced its plans to boost the offering of the original content on the platform from 600 hours in 2016 to over 1,000 hours next year. For investors, more original content means higher costs. Does Netflix have enough money?
The free cash flow in Q3 moved even deeper into minus. Netflix reported burning $506 million during Q3, what is considerably higher than last quarter's $254 million and $252 million burned during the same quarter last year. What it means for investors is that Netflix has profits "on paper" while it is actually burning more cash than ever, say The Motley Fool's analysts. And the trend is very likely to remain the same in Q4. The reason for such a big slump in the free cash flow numbers is the increase in production of original content that Netflix prides itself on.
"The increase in our free cash flow deficit reflects the growth of original content, which we are increasingly producing and owning (rather than licensing). Self-produced shows like Stranger Things require more cash upfront as we incur spending during the creation of each show prior to its completion and release," Netflix said in a statement.
The company estimates the content spendings to grow from this year's $5 billion to $6 billion in 2017, which is definitely something to consider for investors who are encouraged by the 20% surge of NFLX shares and attractive quarterly earnings.