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Netflix Earnings: The Good, the Bad, the Ugly

By Jeremy Bowman - Jan 23, 2020 at 6:05AM

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Here are the details you need to know from the streamer's fourth-quarter report.

Netflix (NFLX 5.03%) stock often swings by double digits following its earnings report.

With its highly anticipated fourth-quarter earnings report Tuesday night, the first since the launch of Walt Disney's Disney+ streaming service, investors were expecting another big move. However, the streaming champ issued decidedly mixed results that left the market puzzled. The stock rose a few points in after hours trading Tuesday, but shares were down 3% in afternoon trading on Wednesday.

Let's take a look at the key numbers on all sides.

The reception desk at Netflix headquarters

Image source: Netflix.

The good

Netflix beat its own subscriber forecast, adding 8.76 million paid subscribers compared to its forecast of 7.6 million. That's the most closely watched figure in Netflix's earnings report, and it was enough to earn cheers from investors after hours. International growth was particularly strong, as the company added 8.34 million members outside the U.S. and Canada. Management also said it was launching mobile-only plans in Malaysia and Indonesia, building on a strategy it had begun in India to bring more viewers under its umbrella.

The company debuted a number of hits in the quarter, including The Witcher, which it said is tracking to be its most-viewed season one show ever, after 76 million households watched the show in its first four weeks. It also highlighted new seasons of The Crown, Big Mouth, and You.

Due to a tax adjustment, Netflix crushed earnings estimates, reporting a per-share profit of $1.30 compared to expectations of $0.53; that gave the company earnings per share of $4.13 for the full year, up 54% from the previous year. Next year, Netflix is targeting an operating margin of 16%, up from 13% in 2019. That shows that at least on a generally accepted accounting principles (GAAP) basis, Netflix's profitability is expanding rapidly.

The bad

Though Netflix beat estimates in its subscriber forecast globally, it came up short in the U.S., where it added just 420,000 new members. That was below its own projection of 600,000, and down from 1.53 million in the quarter a year ago. It was also the clearest sign yet that the launches of new competitors like Disney+ and Apple's Apple+ were having an impact in Netflix's most important market. Meanwhile, the company's subscriber growth forecast for the first quarter calls for just 7 million new members, down from 9.6 million in the first quarter of 2019, which was a record for quarterly adds.

Netflix explained that in the U.S. it was seeing slightly elevated churn levels (more subscribers leaving the service than normal), due to its price hike in May and new competition; management expects subscriber growth to be steadier between the first and second quarters this year, as the content slate is weighted toward the second quarter. Still, the weaker-than-expected guidance may have spooked some investors.

The ugly

Among Netflix bears' biggest concerns is the company's cash burn rate. Netflix had said earlier that it expected cash burn to peak in 2019, which it did, hitting free cash flow of negative $3.3 billion. For 2020, management expects that to improve modestly to a loss of $2.5 billion. In other words, Netflix will still be reliant on the debt markets to fund its own content binge for several more years. Investors who hoped for a quick ramp-up to profitability will be disappointed, as Netflix said it would move "slowly" to becoming free cash flow positive. At its current rate, it won't reach breakeven on that metric until 2023.

Separately, Netflix also made a strange update to its method of counting viewers. Instead of counting a single view once a subscriber has watched 70% of one episode (or movie), as the company had traditionally done, it will now count a view after just two minutes of a program being played. Netflix said that would lift viewership on shows by 35%, but the move garnered criticism on Twitter and elsewhere, as it was seen as inflating the company's viewing numbers.

Watching two minutes of a show is not the same thing as watching a show, and measuring it that way not only makes the metric less meaningful, but it also gives Netflix bad data as it tries to determine which of its shows are resonating with audiences. Viewers aren't getting value from watching half (or less) of an episode of a show -- that just means they didn't enjoy it.

Where Netflix stands today

The leading streamer was one of the best growth stories of the 2010s, rising 4,000% over the last decade. However, the stock has essentially traded sideways over the last 20 months, and is still down about 20% from its all-time high of $423 a share in July 2018. The company continues to grow steadily and still has a lot of room for expansion; profitability is improving as Netflix gains operating leverage from raising prices and growing its subscriber base. Still, there are several reasons to be skeptical of the stock as well, including a maturing market in the U.S., rising competition, and negative free cash flow.

Considering both sides of the argument, the stock seems to be fairly valued today. With a price-to-earnings ratio near 80, Netflix's future growth is priced in, but the company and its brand are stronger than the bears give it credit for. Though it's not what investors in this consumer discretionary stock are used to, the sideways trading we've seen recently may become the new normal for Netflix stock.

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