Netflix (NFLX 0.71%) shares got walloped last week despite the company meeting or exceeding most parts of its guidance. The main reason for investors' dismay was a projected slowdown in international subscriber additions in Q2.
Netflix expects its international growth to slow in Q2. Image source: The Motley Fool.
Following the earnings report, Netflix executives spent 45 minutes talking to two media analysts about the company's results and outlook. Here are five key points that they highlighted.
Just getting started in new international markets
And remember that most of those countries we haven't yet seen the full potential of because we're only in English and only with international credit cards. So over the next couple years as we further localize, we'll be able to see more opportunity.
-- Netflix CEO Reed Hastings
Netflix expanded into 130 new countries earlier this year, which raised investors' hopes for rapid growth outside the U.S. throughout 2016. But while Netflix added 4.5 million international subscribers in Q1, it expects to add "only" 2 million this quarter. Netflix bulls had been hoping for more.
CEO Reed Hastings reminded these investors that there's more to international growth than just showing up and turning the Netflix service on. Netflix added lots of subscribers in Q1 by satisfying pent-up demand in these new markets. However, to fully exploit its international growth opportunities, Netflix will need to support more languages and add more payment options based on consumer preferences in each country.
Relationships with content producers are stable
All of our suppliers either produce for us or license to us and probably compete with us on some level, and we're just always trying to navigate those waters. Very similar to the way networks deal with one another and produce for one another.
-- Netflix Chief Content Officer Ted Sarandos
Many of Netflix's key content suppliers are also competitors. Image source: The Motley Fool.
One issue that many Netflix analysts have worried about is the prospect of Netflix being "cut off" by key content partners like Walt Disney (DIS +0.41%).
Netflix gets lots of content from Disney -- both licensed movies and TV shows and originals like "Daredevil" that premiere on Netflix. Yet the two companies are also key competitors. To the extent that Netflix convinces people to become cord-cutters, it hurts Disney, which generates billions of dollars each quarter in pay-TV affiliate fees.
However, this mix of cooperation and competition is not as unusual in the TV universe as you might think. Netflix's Chief Content Officer Ted Sarandos pointed out that rival TV networks produce shows for one another fairly frequently. Disney makes plenty of money from its relationship with Netflix and it's not likely to throw that away in a futile attempt to bolster the pay-TV ecosystem.
Diving deeper into original content production
[W]hat you're seeing not just on the films but also on several of our series where Netflix is increasingly the studio and the network on those shows, so we are building that efficiency in house.
-- Ted Sarandos
Of course, Netflix can also hedge against the risk of backlash from partners like Disney that are also rivals by bringing some original content production in-house. Netflix aspires to spend billions of dollars a year creating original TV shows and films so it clearly has enough scale to succeed. And as a hot brand, it can attract premier talent.
For now, most Netflix originals will continue to be produced by other studios. However, the company is already starting to produce original content in-house, and Netflix plans to grow this internal capability significantly in the years ahead.
Netflix has started to produce some of its original content in-house. Image source: The Motley Fool.
Original films are producing positive results
Remember, we have a few films under our belt. What I'm really looking at is how broadly people engage with them, how do they play around the world. All of those data points have been really positive.
-- Ted Sarandos
Original films are another relatively new area for Netflix. Based on Sarandos' comments during the earnings interview, it doesn't appear that any of the streaming leader's original films have been smash hits like some of its original TV series.
However, it's still very early. Netflix seems to be perfectly happy with the amount of viewing for its first few original films -- enough that it will continue to invest in this medium. As Netflix gains more experience in feature-length films, it should be able to improve the performance of its films relative to their cost of production.
Cash burn will continue for now
I would say $1 billion [in negative free cash flow] is a pretty good guide for both this year and next year. And really on free cash flow positive ... it depends on the size of the business.
-- Netflix CFO David Wells
Netflix's rapid international expansion and its heavy investments in original content have both weighed on the company's cash flow. In Q1, free cash flow was -$261 million, which was roughly in line with the last few quarters. Netflix CFO David Wells expects the company to continue burning about $1 billion of cash a year in 2016 and 2017.
The pace of improvement after that will depend on how Netflix's growth evolves. The company has shown a propensity to invest heavily in new content and marketing when it sees big growth opportunities. Paradoxically, it's only when Netflix's growth starts to slow that investors will find out just how much of a cash flow machine the company can be.
