Nevertheless, during the subsequent earnings interview, Netflix's management team emphasized that the company remains on a solid growth trajectory. Here are 5 key items they discussed.
Netflix is still leading a revolution
Well, everything that we're seeing is completely consistent with the whole society, not only the US, but around the world, is moving to Internet video and Internet television.
-- Netflix CEO Reed Hastings
While Netflix executives acknowledged that the company didn't grow as much in Q3 as they had expected, they downplayed the importance of this miss. Netflix still added 3 million streaming subscribers last quarter, and management's Q4 guidance calls for adding 4 million subscribers.
Additionally, Reed Hastings pointed out that Internet television more generally is just starting to gain steam. Just last week, Time Warner announced plans to offer its popular HBO network as a streaming service rather than selling it through pay-TV providers, while CBS launched a new streaming service that will make CBS broadcast network content available on-demand for $5.99/month.
Netflix remains the runaway leader in Internet video, though. Netflix's management team believes that as more Internet video services take root, Internet TV viewing will become even more mainstream and Netflix will benefit from its first-mover position.
International losses could remain significant
I would say to give you some sense of the magnitude, we peaked out of [sic] international loss at $105 million. We guided in Q4 to a number that's slightly lower than that. In terms of the potential down the road, we certainly could see that level of investment.
-- Netflix CFO David Wells
The flip side of Netflix's long-term focus is that the company is not trying to maximize earnings today. Netflix announced last week -- in bold print, no less -- that the international markets it entered between 2010 and 2013 are now collectively profitable. Netflix's contribution margin in Canada is now on par with its domestic streaming margin.
As a result, Netflix is accelerating its entry into new markets. This is costly in the short term. International losses peaked at $105 million in Q4 2012, and Netflix's international segment has lost nearly $1 billion in the past 4 years. Netflix cut its international contribution loss to $15 million by Q2 of this year, but it is projecting that this could rise to $95 million in Q4.
Netflix's expansion into 6 new European markets is causing the current spike in international losses. Management is giving investors fair warning that the costs of opening new markets could overwhelm the profits from older international markets for a few more years. In the short run, Netflix's international losses could increase beyond the level projected for Q4.
A 7-year process
[I]t took in the U.S. seven years to get to about one-third of broadband households ... [I]n the developed markets ... we're targeting those kind of numbers, getting to one-third of households over seven years.
-- Netflix CEO Reed Hastings
While Netflix's management is urging patience, investors won't have to wait forever for the international segment to become profitable. From the time that Netflix began offering streaming video content back in 2007, it took about 7 years for it to reach one-third of the U.S. broadband household base.
Netflix hopes to achieve a similar trajectory outside the U.S. in developed markets like Europe. If Netflix's new markets can achieve within 7 years the level of profitability seen in the U.S. today, it will be well worth the wait and initial investment.
HBO over the Internet isn't a big threat
We and HBO have completely different content. So I don't think it will be a significant impact at the consumer level. As we bid for content, that's more significant ...
-- Netflix CEO Reed Hastings
Time Warner revealed its plans to make HBO available to non-cable subscribers on the same day as Netflix's earnings report, so that development was top-of-mind for many investors. HBO is one of the few potential competitors that can eclipse Netflix in terms of critically acclaimed original programming. Yet Netflix executives don't see this as a threat.
After all, Netflix and HBO are just 2 "channels" in the new world of Internet TV. Since they have different content, people who like the type of shows that Netflix and HBO specialize in are likely to subscribe to both.
If anything, the competition between Netflix and HBO could be stiffer on the supply side. If HBO decides to expand the content library of its online service by bidding for other networks' content (or even content from other Time Warner subsidiaries), it could drive up Netflix's content costs.
Great content travels well
So Orange Is the New Black was by far the most watched show in both France and Germany, and in fact all of the markets that we launched. So it tells you that with all the differences in taste, that they all rallied around that show.
-- Netflix Chief Content Officer Ted Sarandos
Netflix content guru Ted Sarandos pointed out that the most popular title in all of Netflix's new markets was the original series "Orange Is the New Black." To some extent, there's a novelty factor at play: new customers may have zeroed in on that show because it was new and heavily promoted.
Nevertheless, this phenomenon shows that Netflix's original content has global appeal. That's important because Netflix can buy up global rights to its original shows in a cost-effective manner. By contrast, when it licenses other networks' content, it needs to pay for each country where it wants the streaming rights.
Foolish bottom line
Netflix definitely delivered disappointing news with its Q3 subscriber growth and Q4 forecast last week. Considering its inflated stock valuation, it's not surprising that shares plummeted last week.
That said, Netflix's long-term growth story remains intact. Netflix executives remain confident in the long-term growth of Internet TV, and Netflix is the clear leader in that field. Netflix is still on track to produce much higher earnings a decade from now, when its international markets will be mature. Whether that can justify its current share price remains to be seen, though.
Adam Levine-Weinberg is short shares of Netflix. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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