Netflix, Inc. Cools Down in the Summer Quarter

Some aspects of the streaming video expert's third quarter report looked very good, but domestic growth was a disappointment.

Adam Levine-Weinberg
Adam Levine-Weinberg
Oct 14, 2015 at 10:39PM
Consumer Goods

High-flying streaming video titan Netflix (NASDAQ:NFLX) reported mixed third-quarter results on Wednesday afternoon. While overall subscriber growth and profit came in roughly in line with the company's guidance, domestic growth slowed again in Q3 after two quarters of acceleration.

For most companies, Netflix's results would have been perfectly satisfactory. However, Netflix isn't most companies. Naturally, investors are feeling a bit of a letdown after Netflix's strong first-half performance caused the stock to more than double since January.

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Netflix's quarter by the numbers
During Q3, Netflix's revenue totaled $1.74 billion, while earnings per share reached $0.07. Analysts (on average) had been expecting slightly better performance on both metrics: revenue of $1.75 billion and EPS of $0.08. The results were also roughly in line with the guidance Netflix had provided back in July.

Once again, Netflix's international operations outperformed the company's expectations. The company added 2.74 million subscribers in its foreign markets: 14% ahead of the guidance for an increase of 2.4 million in its international subscriber count.

International revenue of $517 million was slightly behind Netflix's guidance of $524 million because of the strong dollar. Nevertheless, the company's international contribution loss was better than expected at $68 million -- Netflix had projected a $77 million contribution loss.

Growth was less than stellar in the domestic market, though. Netflix added 0.88 million domestic streaming subscribers in Q3, down from 0.98 million a year earlier. (Additionally, adding 0.98 million subscribers last summer was considered a weak performance at the time.)

Netflix's domestic growth is slowing again. Photo: The Motley Fool.

Despite Netflix's slower-than-expected domestic subscriber growth, domestic streaming revenue and contribution profit fell only slightly below the company's guidance.

Looking ahead
Netflix's initial guidance for the fourth quarter calls for 1.65 million domestic streaming subscriber additions, down from 1.9 million a year earlier. On the flip side, Netflix expects to record international subscriber growth of 3.5 million in Q4, up from 2.43 million in Q4 2014. The impact of Netflix's ongoing international expansion will thus more than offset slowing domestic growth.

That said, Netflix has been consistently losing money in its international operations because of its rapid expansion and the high costs of getting started in a new market. Netflix launched in Japan last month and is launching in Spain, Italy, and Portugal during October. As a result, it expects to report a bigger loss than ever ($117 million) in the international streaming segment this quarter.

Meanwhile, slower subscriber growth in the profitable domestic market means potentially slower gains in contribution profit there. Netflix therefore expects its operating income to decline sequentially from $74 million last quarter to $49 million this quarter, reducing EPS for the fourth quarter to just $0.02.

Of course, it's possible that Netflix will record a blowout fourth-quarter performance, as it has frequently done in the past. The company blamed its slowing domestic growth in part on the transition to chip-based credit and debit cards in the U.S., which caused card numbers to change and thereby prevented Netflix from collecting subscription fees.

If that's true, then it should be a very short-term issue. Once people realize their Netflix subscriptions are being canceled because of receiving a new card, they should update their payment information to rejoin the service. On the other hand, if growth continues to slow, it could represent the first sign that Netflix is starting to saturate the U.S. market.