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Netflix Posts Solid Q1, But Stock Plummets on Weak Outlook

Netflix shot up to 81.5 million streaming subscribers worldwide, as the company posted customer gains that beat Wall Street estimates and topped earnings estimates for the first quarter of 2016.

But shares fell as much as 12% in after-hours trading after the company issued weaker-than-expected second-quarter guidance for subscriber gains.

For the three months ended March 31, the company reported revenue of $1.96 billion and earnings per share of 6 cents. Analysts had expected the company to post revenue of $1.97 billion and EPS of 3 cents.

Netflix added 2.23 million U.S. subscribers and 4.51 million internationally for the period. Wall Street projected that the No. 1 subscription VOD company would add 1.82 million U.S. streaming subs and 4.18 million internationally, after Netflix expanded into 130 additional countries in January to reach 190 territories worldwide.

“We are pleased Netflix is finding acceptance around the world,” CEO Reed Hastings wrote in the company’s quarterly letter to shareholders. “We have lots of work to do to make Netflix more relevant market by market, but the opportunity is amazing.”

Of Netflix’s 81.5 million members at the end of Q1, 42% are outside of the U.S.

For the second quarter of 2016, which is historically weak for the company, Netflix said it expects to add 500,000 subs in the U.S. and 2.0 million internationally. Analysts have been projecting that Netflix will net about 600,000 U.S. subscribers and 2.9 million overseas in Q2.

In the States, the second-quarter forecast is tempered by the company’s looming price hike for millions of subs on the two-stream plan paying $7.99 per month, which will increase to $9.99 next month. Investors also will be watching to see the effect of Amazon’s move to split off Prime Video as a standalone subscription service for $8.99 monthly in the U.S.

Hastings, on a call with investors Monday, downplayed the threat posed by Amazon’s shift, characterizing it as “part of the natural evolution” of the shift from linear TV viewing to “Internet TV.”

Regarding competition, Hastings called Netflix “but a little boat in a vast sea” in the letter to shareholders. Besides rivals like Amazon and Hulu, he cited video games, web surfing, Internet piracy, and watching YouTube and linear TV as competing for attention.

“While we’ve grown from zero to 47 million members in the USA, HBO has also grown, which shows how large the entertainment market is,” he wrote. “We earn a tiny fraction of consumers’ time and money, and have lots of opportunity ahead to win more of your evenings away from all those other activities if we can keep improving.”

Today, more than half of Netflix’s U.S. members currently pay either $7.99 or $8.99 for the HD two-­screen plan. Hastings reiterated that the company expects “modestly increased churn” because of the rate changes this year.

“We will phase out this grandfathering gradually over the remainder of 2016, with our longest­-tenured members getting the longest benefit,” Hastings wrote. “We are rolling this out slowly over the year, rather than mostly in May, so we can learn as we go.”

Netflix said the higher subscriber fees will let it boost content spending — projecting that to rise from $5 billion this year to more than $6 billion in 2017 (on a profit/loss basis). The company currently has $2.4 billion of long-term debt, and said it plans to raise additional capital through high-yield bonds later in 2016 or in early 2017.

The first quarter of 2016 marked Netflix’s “most ambitious slate of content” releases to date. Since the Feb. 19 premiere of Judd Apatow’s “Love,” it has debuted at least one new show or feature film every week through the end of the quarter, including the second season of “Marvel’s Daredevil” and the fourth season of “House of Cards.”

Netflix “underestimated the positive acquisition impact of our major original content debuts” for the first quarter, Hastings said, by way of explaining why its previous forecast of 1.75 million U.S. net adds was low.

On its foray into movies, a move that has been resisted by theater chains because they want to preserve exclusive distribution windows in cinemas, the company said Netflix is investing about 5% of its cash content budget in original films. Original movies in the second half of 2016 include “War Machine,” a satirical comedy starring Brad Pitt, and “Mascots,” an ensemble comedy from Christopher Guest. The 2017 lineup includes Bong Joon­Ho’s “Okja,” and “Bright,” an action film starring Will Smith and directed by David Ayer.

“As we learn, we may spend beyond that, once we’ve established that new, fully­ exclusive movies debuting on Netflix creates more consumer excitement and member viewing than the territory­-by-territory licensing of nine-­month-old ‘pay one’ movies that are also available on TVOD and DVD,” Hastings said.

Meanwhile, asked on the call if Netflix would make its films available on Screening Room — the controversial day-and-date service backed by Sean Parker — chief content officer Ted Sarandos unsurprisingly answered affirmatively.

“We wouldn’t mind having our films available on” Screening Room, Sarandos said. “It would be a great way to get content to consumers, if they want to pay for it.” The stealth startup is said to want to offer new releases to rent for home users for up to $50 a pop — making it nearly inconceivable that anyone would watch a Netflix title through Screening Room rather than the Netflix service.

As for whether Netflix would be interested in acquiring media companies like Paramount Pictures or Starz, Hastings responded by noting the company has never engaged in M&A in its 20-year history. “I think that speaks for itself,” he said.

Also on the call, Hastings was asked if Netflix would offer offline viewing of video, the way Amazon Video and YouTube Red do. “We should keep an open mind on this,” Hastings responded. “We’ve been so focused on click-and-watch and the beauty and simplicity of streaming. But as we expand around the world, where we see an uneven set of networks, it’s something we should keep an open mind about.”

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