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Netflix Management on Earnings: Don’t Expect Quite So Much Growth

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Netflix  (NFLX)  posted a strong quarter, but the language found in management’s guidance poses a threat to the narrative that Netflix will sustain its recent subscribe growth resulting from the pandemic

The stock fell 10% to $473 a share in postmarket trading and had been hot into earnings for the most part.

Here’s what the results were versus Wall Street expectations: 

  • Revenue: $6.15B v. $6.08B (actual: +25% year-over-year)
  • Paid Net Adds: 10M v. 8.2M (+270%)
  • Operating Margin: 22% v. 18% (+80 basis points year-over-year) 
  • Adjusted Earnings Per Share: $1.59 v. $1.82 (+165%) 
  • Free Cash Flow: $899M v. $262M (loss last year) 

Management said it incurred $340M of non-recurring expenses, much of which was the absence of a tax benefit that caused a far higher tax rate than expected, leading to the EPS miss. Helping the opening margin was that management kept marketing spend in check, as Netflix enjoys the benefit of scale while reaching more subscribers. 

But it was the guidance that did the stock in. 

The company said growth is slowing, as the stay-at-home tailwind fades, contrary to the recent belief in the market that Netflix is reaching new heights of growth in the COVID environment. 

Here’s what management said:

"As we indicated in our Q1’20 letter, we’re expecting paid net adds will be down year over year in the second half as our strong first half performance likely pulled forward some demand from the second half of the year. Growth is slowing as consumers get through the initial shock of Covid and social restrictions.” 

The company did say it expects a breakeven-to-positive free cash flow result for 2020, up from a prior estimate of negative $1 billion. But that’s because of a recent pause in production. In 2021, the company expects free cash flow to be negative again. Some analysts had hoped for Netflix to be closer to generating positive free cash flow on a sustained basis than what management is implying. 

For the third quarter, management is guiding for revenue of $6.3B on paid net subscriber adds of just 2.5 million. That’s against analyst estimates of 5.36 million. The guidance implies a substantial decline year-over-year.  

Ted Sarandos, current Chief Operating Officer was also appointed Co-CEO on the earnings release. 

Leading into earnings, the stock was reflecting an incredibly optimism scenario. While down 3.8% in the six days leading into earnings, it was up 25% since June 8, enabling a valuation of 49 times enterprise value to next year’s EBITDA (earnings before interest, tax and non-cash expenses). Many analysts value the company at 40 times. 

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