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When Broken Records Provoke Yawns: Highlights From Netflix's Report

By Evan Niu, CFA – Updated Apr 21, 2019 at 10:25PM

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The tiny miss on the top line is nothing compared to the bigger long-term growth story for the streaming pioneer.

Check out all our earnings call transcripts.

Netflix's (NFLX -2.04%) record-breaking subscriber growth didn't seem to impress the market too much...which is to say the market probably missed the point. In this episode of Industry Focus: Tech, host Dylan Lewis and contributor Evan Niu sift through the streaming specialist's fourth-quarter report and explain why Netflix's long-term picture is still so exciting. Click play to find out why increasing competition from the likes of Disney+ (DIS -0.01%) isn't a nail in the coffin for Netflix, what to watch from Netflix's new CFO, and more.

In the latter half of the show, the guys talk about why the departure of Snap's (SNAP -1.36%) CFO is a really, really bad sign for the the Snapchat operator's future, and what investors can learn from the whole Snap debacle.

A full transcript follows the video.

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This video was recorded on Jan. 18, 2019. 

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, January 18th, and we're talking about some recent results from Netflix and some sad news from Snap. I'm your host, Dylan Lewis, and I'm joined on Skype by's Evan Niu. Evan, what's going on? 

Evan Niu: It's cold. It's snowing in Denver, it's going to be a cold weekend. 

Lewis: That sounds like my kind of conditions, Evan. I'm going to be going snowboarding this weekend and I would love to have some nice, fresh snow to be on. I think we're going to have to settle for a day or two old snow, though, where I'm going.

Niu: Well, I'm from Texas. I'm not used to all this white stuff.

Lewis: [laughs] Colorado might have been a curious choice for you, then. Well, more of the same over here. I think we might be getting a little bit of a wintry mix. Nice to know that we're dealing with the same conditions even though we're miles and miles apart, Evan. [laughs] 

We have quite a bit of news to cover on today's show. There's a lot going on in tech this week. We had the beginning of earnings season, which everyone gets really excited about. Nice to get those fresh results from companies that they follow. And then, we also have some updates before companies started reporting, and that's what we're going to be focusing on with Snap.

Let's kick things off talking about Netflix and some of the results they posted. This is a company that a ton of Fools follow and are always eagerly awaiting updates on.

Niu: It's a very polarizing company. The stock is one of the most volatile earnings movers in general. It's always a fun one to watch. Results were mixed overall. Revenue came in at $4.19 billion. Market was expecting $4.21 billion, so a tiny miss there. The good news is, earnings per share came in at $0.30 versus the $0.24 consensus. They actually were able to beat on the bottom line despite a slight miss up top. 

One of the big things this quarter is that they recorded a record number of subscriber growth globally. They added 8.8 million total members, of which 1.5 million was in the U.S. and 7.3 million internationally. That's a huge growth number outside of the U.S. They're adding a ton of members. Now, worldwide total memberships are around 139 million.

Lewis: With this business, there's always been a focus on what the top and bottom lines looked like. But so much of the growth story for them is what's going on with the subscribers. For them to be putting up a big number like that, and for them also to be forecasting they'll be putting up another pretty big number next quarter, is super encouraging, especially when you have the news earlier in the week that they're going to be raising prices. Those are two really easy levers for them to continue to raise revenue down the road. 

Niu: That forecast, they're expecting to add 8.9 million global net additions in the first quarter. Like you mentioned, that's another back-to-back record of membership additions. I think that's pretty encouraging, even though their revenue forecast for the first quarter came in a little bit light relative to expectations. They were expecting about $4.5 billion in revenue, whereas analysts were at $4.6 billion. Again, kind of a minor shortfall there. But I'm still really encouraged by the strong membership numbers.

Lewis: Yeah, I think that long term, you have to love that those numbers are going in the right direction. At a certain point, I think the other numbers catch up. If you're really sweating the fact that Netflix missed by $0.2 billion on their top line, you're not really focusing on the right part of the narrative for this company.

Niu: Exactly. That's been the long-term story. They keep on investing heavily into this original content, and that really continues to drive this membership growth. As you mentioned earlier with this price increase, they're really milking more out of all of their members. That's going to help drive some growth, too, even on top of this membership growth. These price increases are effective for a lot of markets, they're rolling out these increases. And then, at the same time -- we've talked about this before -- them cutting out mobile in-app subscriptions, which is a blow to companies like Apple or Alphabet. That's going to help them boost their margin between cutting costs on distribution, increasing up-front pricing. The mobile side of it really affects new and returning customers. Knowing that they're still able to add new members or returning customers, none of which will be subject to those mobile platform fees if they're signing up through mobile platforms, a lot of things to like here.

Lewis: I think if you're looking out beyond the next quarter -- that's what we're talking about with the member stuff -- and start looking at what 2019 and 2020 look like for this company, they've benefited for a very long time by being one of the first and only streaming companies. A lot of the competition has started to catch up a little bit. I think some of that competition is really going to intensify as we get into late 2019 and start looking at 2020. We're going to see a lot of the Disney stuff roll off of their catalog, and we're going to start to see Disney+ come out and see what the appetite is there for consumers. 

Niu: Right. That's something they actually addressed directly in the shareholder letter. A lot of investors and analysts really focus on this competitive piece. As you mentioned, Disney+ is a big one. Disney has a huge content library, and they're pulling all of it off of Netflix. But Netflix's point was, first of all, they estimate that at this point, they're about 10% of all TV screen time in the U.S., which is a mind-boggling figure, that one service grabs that much attention from all of us collectively. They also note that they compete with all forms of entertainment. It's not just streaming. They also compete with video games and all sorts of other stuff. They even said they're losing out to Fortnite, because Fortnite's been so popular lately. I think their point is, people are focusing too much on other streaming services as competition when entertainment is really fragmented. What they're focusing on is delivering a valuable experience to members that can justify what those members pay each month and potentially price increases going forward.

Lewis: Yeah. I actually talked about this on a show that'll be going up Tuesday with Dan Kline. We were doing a look at what to expect from Disney in 2019 and 2020. We talked a lot about Disney+. If you're looking at services that have a monthly cost of $12, $10, Disney said they're going to be pricing below Netflix because of the content library differences, it's pretty easy for consumers to have several of them and look at, "OK, I'm willing to have HBO, Netflix, and Disney+. I'm going to cut my cable and just pay for internet." I don't know that any of these services are mutually exclusive, but we haven't gotten to the point where a lot of consumers have these different packages from all these different providers. I think in the next year or two, we'll start to see, how many are people willing to navigate between and pay for all at the same time?

Niu: I think that's going to be interesting, too. There are a ton of services coming out. The appeal of cord-cutting has always been, you get rid of this $50-$70 cable bill, then you pay $10 a month for Netflix or whatever it is. But when you start adding three, four, five streaming services between HBO Now, Hulu, Netflix, Disney+, whatever Apple does this year, [laughs] you basically get right back up to that $50-$70 a month, which offsets what you were hoping to save by cutting the cord to begin with. 

Lewis: Yeah. I think that the future of streaming and what consumption looks like is just cable in disguise. It's cable in the sense that you have various packages that you're looking for, and instead of them being channel packages, they're the service packages. It's you deciding whether you want Netflix and Disney+ or just Netflix because of the content that's on there. 

Niu: I think the key is going to be, they're not exactly mutually exclusive, but there's certainly a limit. People aren't going to sign up for 10 different services. I think the key for Netflix is, as long as they can always be a constant in that mix, that people will always prioritize, "OK, Netflix is a given. We want that." And then they go off and choose between the other ones, mix and match which services appeal to them the most. As long as Netflix is a core staple that everyone subscribes to, that's going to be the key as competition heats up. 

Lewis: Yeah, they benefit from the brand name. I think they benefit from being the first mover. It's so closely tied to the streaming phenomenon in general, the idea that Netflix is the default. That helps them out so much. 

Going back to their report for a minute, one of the things that we've watched with this company over time is, what does the debt load look like? I know that management has a slightly different philosophy about debt than maybe some of the other companies that a lot of people follow. It looks like we're going to see more debt coming onto this company's books. We've certainly seen it in the most recent quarter, and there's no sign of that slowing down.

Niu: Exactly. They've been adding so much debt in recent years. At this point, it's over $10 billion. They added $4 billion in 2018 alone. That's really hurting some of these other numbers. For example, they expect free cash flow in 2019 to be comparable to 2018, which is to say negative $3 billion, which is not a great number to forecast. But, again, it's this long-term investment in the content business. 

Another interesting thing that happened is they also named a new CFO earlier this month, the beginning of January, Spencer Neumann. They hired him way from Activision Blizzard. Their outgoing CFO has been CFO since 2010, it's almost 10 years that he's been leading their finances. Under David Wells, they justified this growing debt load by pointing to their debt-to-market-cap ratio, which I've always thought was a really misguided way to look at it. Market cap is just what the market's doing at any given time, whereas your debt is very much a tangible number on your balance sheet that you're paying interest expenses on. So, tying the debt to the market cap issue as a way to justify this endless amount of debt, I've always thought, was a wrong approach. So, one thing I'm interested to see going forward is if this new CFO changes that strategy or changes that rationale at all. 

Lewis: I'm reminded a bit of that famous quote, "The market can remain irrational far longer than you can remain solvent." I think the reason why most people tend to focus on looking at debt relative to cash, maybe a net debt position or net cash position, is because if you're focusing on market cap or share price, that can fluctuate pretty wildly. Having the cash is the easiest indicator of whether you're going to be able to pay off the debt that you're facing.

Niu: Right. If you're using this debt-to-market-cap ratio to justify it, what happens when your market cap drops by 25% over the course of a few months? And Netflix does that all the time because it's so volatile. Then, all of a sudden, your rationale is shot. And at that point, what do you do? And in the letter, they mentioned, "We do continue raising debt capital as long as the marginal after-tax cost of debt is lower than the marginal cost of equity." But, again, I think it's kind of a strange approach. They could easily just sell more stock and secondary offerings. It might have a higher cost of equity, but it doesn't have interest expense associated with it. Again, it's a little too early to know if he's going to change how they approach their capital allocation strategy. But that would be something to keep an eye on.

Lewis: That minor beef aside, I think looking at the results, where this company is going, I know that the market reaction was pretty light to this. They might have even been down a little bit on these results. I look at this and I see everything that I want to see from this company. They might have missed a little bit on the top line, but everything else is going in the right direction. You want to be adding subscribers, especially knowing that they continue to have a willingness to pay more than what the company is charging. I look at this report and I'm pretty happy.

Niu: I agree. Overall, I'm an investor, I've been a long-term investor. I think the record subscriber numbers, record forecasts on subscriber numbers, those are very encouraging to me, even though I might disagree with some of their debt strategy. But overall, I thought it was a very strong report. A lot of analysts are still bullish. A lot of price target increases today right after the results.

Lewis: All right, Evan. Switching gears and talking about another big story in tech. We got news earlier this week that Snap's CFO, Tim Stone, was going to be leaving the company. This is one of most dominant headlines that our readers and listeners probably saw this week.

Niu: It's pretty big news. They only poached Tim Stone away from Amazon back in May. It's only been eight months. And they got him with a $20 million pay package. [laughs] He's giving up quite a bit by leaving so soon. That compensation package included $19 million in standard equity units that vest over time, as well as a $1 million grant that invested within six months. As of last Form 4 filing, he still had like 2.3 million shares. But there's a lot that he's leaving on the table. And it's never good news when you're losing two CFOs in under a year. 

Lewis: He was there to replace Drew Vollero, who left the company. As a reminder for some folks who may not be as familiar with Tim Stone, his pedigree, he spent 20 years at Amazon before coming to Snap. Certainly not a guy that needed money, but to see him leave $18 million -- or, I've seen some estimates at $16 million -- he left a lot of money on the table, one way or the other, to leave. That says to me that he was not happy with the situation at this company. 

Niu: Right, exactly. We were talking about this earlier, there's a Bloomberg report, Stone apparently was interested in being really ambitious and wanted a promotion. He wanted an even higher pay package, and he also wanted to be promoted to COO. Then he went behind Evan Spiegel's back to talk to the board, which, of course, Spiegel is part of. [laughs] And, apparently, that caused a lot of tension between the two. 

Lewis: And that COO role was vacant because Imran Khan, who was the chief strategy officer at the company, and was there for several years, left last year to pursue his own opportunities. He's working on some e-commerce start-up. So, he'd left for some other opportunities. Stone, it wasn't clear that he was leaving for any reason aside from not necessarily getting along, or not necessarily having the same vision as Evan Spiegel.

Niu: Spiegel's management has been called into question a lot lately. There are reports that the previous CFO, Drew Vollero, left in part because Spiegel was so obsessed with making Spectacles. We've talked about Spectacles at length on this show, how they seem to be more trouble than they're worth, no one buys them, no one uses them, but Snap keeps putting all this money into developing and marketing and distributing these things. And apparently, Spiegel was just so obsessed with this, and Vollero was really against this wasteful spending on hardware development. Obviously, we don't know the exact circumstances around Stone's departure now, but the point being, I don't think Evan Spiegel is a great leader. [laughs] 

Lewis: Yeah, I think a lot of people thought Stone was going to be the adult in the room, so to speak, the guy that at least got them on the up-and-up with their books, maybe got them focused on the right priorities and investing in the right places. For him to be leaving, I think, does say quite a bit about Spiegel. 

It's also concerning because, you look at their management team over the last two years, it's been a mass exodus. [laughs] You know? You look at their current executives and directors page on the company website, only Bobby Murphy and Evan Spiegel, the two co-founders, have been in their current positions prior to July 2017, and the company went public in March of that year. That really doesn't speak to a management team that people want to be a part of and are ready to work for long-term. 

Niu: Yeah, exactly. There's also news this week that broke that apparently, their head of IR had left back in November, but it wasn't reported until just now. Specifically, if you're an investor, the two positions that are pretty important to you are the CFO and the head of investor relations. With no head of IR, and the CFO on his way out, that's a pretty terrible combination for investors in terms of corporate governance, investor transparency, and all these things. 

Speaking of investor transparency, Stone, to his credit, was the one that implemented financial guidance. Snap previously never provided any financial guidance, which left investors in the dark about what's going on, what to expect the next quarter, on top of not having any votes or any way to actually influence the company. These are just a lot of really negative developments back to back. 

Lewis: If there's a silver lining looking at the Stone news, I think, in digging into what his comp package was, we can say that Snap as a company has gotten better at setting up their share vesting schedules. One of the big criticisms that we had of this company was, when they IPO-ed, Evan Spiegel immediately received, what, a $650 million share grant? 

Niu: Roughly, yeah. As a bonus for taking the company public. He'd sold like $200 million or $300 million of the stock in the IPO, and then they just gave him another $600 million or $700 million just for taking the company public. [laughs] Certainly, he's looking to enrich himself, but he might not be as interested in enriching other people.

Lewis: Yeah. That wound up being a very costly decision for them because they had to realize all of that grant immediately. It was such a large grant, they didn't have it vest over time, so it hit their books all at once. With this grant that we saw with Stone, it was in equal installments over 48 months or something like that. So, clearly, they're thinking a little bit more long-term with how they're giving executives their shares over at Snap. 

Niu: Yeah. That was definitely a much more traditional way of structuring a vesting schedule. 

Lewis: In the flurry of the news around this company, what might have gotten lost a little bit is, they're going to be reporting earnings in early February. They did issue a statement around what to expect. They said that they'll be reporting results that are, quote, "slightly favorable to the top end of the previously reported quarterly guidance ranges." If you want to go back and look at what those numbers are, the company guided for $355 million to $380 million in revenue and adjusted losses of somewhere between $75 million and $100 million. Near the top end of that guidance, it's about 30% year-over-year growth. Evan, this is a deceleration from what we've seen from this company over the last couple of quarters.

Niu: Right. They went public so early in their life that they were able to put up these really strong growth numbers, but they're coming off of a small base, so it's kind of misleading how impressive that is. But now that we're seeing growth decelerate, as they're trying to ramp this ad business and they keep struggling -- they've been trying to automate it to scale it up. They're making some progress, but there's no question that the business is slowing down a little bit, in terms of growth. 

Lewis: Yeah. And they didn't provide any specific DAU guidance in that quarter before, but they did say that they expected to lose users sequentially from Q3. One of the things that I'm most interested in with this upcoming report is, they're hitting near the top end of what they were expecting in revenue. They'd said that they were expecting to lose users. Is that what's happening? If that's happening, where's the revenue growth coming from? Where's the outsized impact coming from? Is it that they're really putting out more impressions, they're creating more ad opportunities than they thought they were going to? Is it that prices for ads are rebounding? Those are the two big dynamics for an ad-based business.

Niu: Right. Obviously, user metrics will be important, as always for any social media company; and, like you mentioned, pricing. I always like to look at their cost structure. We've also talked about this a lot over the years that we've been covering this company. I still think their cost structure is not very sustainable. Looking at hosting costs per user, comparing that to the average revenue per user, and seeing if they're making any progress with scaling. The way they have the company set up, it's just so difficult to actually scale, which is what most people tend to like about tech companies. [laughs] 

Lewis: Yeah. Spreading the fixed costs out over more and more users is what makes the numbers work for so many of these companies. When you have variable costs tied to usage, you just can't do that.

Niu: I think, on the ad side, there have been a lot of anecdotal reports about the quality of the ads on the platform deteriorating, continuing to get worse and worse, which doesn't give you a lot of confidence. If they're not attracting quality advertisers, that's also something to be on the lookout for. 

Lewis: Yeah, I've joked with you in the past that I've gotten some very untargeted ads on Snap, ads that are not meant for a 28-year-old man, but maybe a woman. Which is something that speaks to a lot of the results that we see in the digital marketing space. Jason Moser has talked about this on MarketFoolery. I believe it was a Cowen research study they put out to a bunch of ad buyers and said, "If you could choose between putting all of your clients' ad budgets between Instagram Stories or Snap Stories, where are you spending your money?" And 100% of respondents said Instagram Stories. That says all you need to say about where Snap stands in ad budgets. And when you're going up against a Goliath like that, it's really hard to make up ground.

Niu: Yeah. I'm not surprised by that 100% bigger at all. [laughs] 

Lewis: [laughs] We might briefly follow up on the results if there's anything surprising in there. I think it's always good to give people a couple of different things to look at as a company is reporting. Anything else before we wrap up here, Evan?

Niu: One other thing that happened during the week is, they're also losing their head of HR, Jason Halbert. He's always been a very controversial head of HR, wasn't really qualified since he had no prior experience in HR, but he's just friends with Evan Spiegel. There were some previous reports about how bizarre and borderline inappropriate stuff this guy would say to employees. And that's coming from your HR chief, that's kind of a weird match. I'm not going to get into it since this a family-friendly show. 

Lewis: Yes. I appreciate your discretion, Evan. For folks that are interested, you can do a little searching and maybe find it. This is all to say, a lot of this stuff that we originally saw as red flags at this company still exist, and we haven't seen a willingness to address them. If Evan Spiegel was willing to say, "You know what? I'm not the guy, I'm not the leader. I'm a product person, but I don't have the ability to manage this company that at a time was worth almost $30 billion," and he brought in a good management team and surrounded himself with people that were going to challenge him, make the company better, that might be something that a lot of people could get behind. I don't think that's what we've seen. 

Niu: It's crazy, the fact that they were even worth $30 billion at one point, or anywhere close to that. Even today, they're worth something like $7 billion or $8 billion, which I still feel like is overvalued for what we've seen of this company. 

Lewis: Yeah. I think they're going to be somewhere around $1.1 billion in trailing sales, maybe $1.2 billion in trailing sales after this most recent report. That still puts them at a pretty hefty sales multiple, for a company that shows no signs of profitability anytime soon and is losing members.

Niu: Yeah. They can't scale, their management's in disarray. All sorts of problems. But they're still, like you said, trading at pretty nice premiums. I think there's a big disconnect there. I don't know where the downside is.

Lewis: Yeah, me neither.

Niu: I feel like this stock is still overvalued, even at $5 or $6. 

Lewis: Yeah. We'll just have to see. I don't think either you or I are going to be the one fighting to catch a falling knife with this company. That said, I think it does provide a lot of really good lessons to investors. That's why we've spent so much time on it, even though it's a company that we're both bearish on. We talk so much about the corporate governance issues, we talk about the cost structure issues, where they stand in the digital ad landscape. This is a company that a lot of people might have bought as their first stock. It's a pretty widely held company, if you look at a lot of Robinhood holdings, which is a proxy for what millennials are investing in. I hope that, if nothing else, it provided a lot of good lessons to people because it might just be that, it might be the price of an education, what's happened with Snap's stock.

Niu: I think that's a good point. You're absolutely right. The way that they've done a lot of things, love it or hate it, it's very unique and different. To see how these decisions play out over time is definitely something where investors could learn. Like, no voting for public investors, this cloud storage hosting strategy we've talked about. There are a lot of things that they've done that are really unique and different, and it wasn't clear at the time initially if it would be a good or a bad thing. Obviously, no voting is a bad thing. [laughs] But, to your point, I agree that there's a lot of interesting things that have played out that have a lot of valuable lessons for investors.

Lewis: If there's anything worth checking in on after we see results, we'll be happy to do that. Evan, thanks for hopping on the show!

Niu: Thanks for having me!

Lewis: Listeners, that does it for this episode of Industry Focus. If you have any questions, or if you want to reach out and say, "Hey," you can shoot us an email at [email protected], or you can tweet us @MFIndustryFocus. If you want more of our stuff, subscribe on iTunes or check out the Fool's family of shows over at You can also catch all the videos from this podcast over on YouTube. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass! For Evan Niu, I'm Dylan Lewis. Thanks for listening and Fool on!

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Dylan Lewis owns shares of GOOGL, AMZN, AAPL, and Walt Disney. Evan Niu, CFA owns shares of AMZN, AAPL, Netflix, and Walt Disney. The Motley Fool owns shares of and recommends ATVI, GOOGL, GOOG, AMZN, AAPL, Netflix, and Walt Disney. The Motley Fool has the following options: long January 2020 $150 calls on AAPL and short January 2020 $155 calls on AAPL. The Motley Fool has a disclosure policy.

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