Netflix share price drops on Q3 paid subscriber and EPS miss

Netflix share price falls on subscriber miss

Of Tuesday’s US earnings releases – if Snap was the company that beat handsomely on analyst estimates, it was Netflix that failed to live up to Street expectations.

We provide a 60 second rundown of Snap’s Q3 report here.

Overall, Netflix missed on earnings and paid subscription additions, though beat on revenue estimates. That top line beat did little to offset investor disappointment, with Netflix trading down 5.71% to $495 per share in after-hours trade.

Expectations around Netflix have ratcheted up in recent times – with the pandemic acting as a key tailwind for the streaming giant, as government mandated lockdown laws across the globe force individuals to spend significant time inside their homes and cut of many forms of traditional entertainment.

That pandemic thesis, to be sure, looks to have been correct up until the point it was not: Netflix added over 25m paid subscribers during the first two quarters of FY20 – 15.77m in Q1 and 10.09m in Q2. That impressive growth whipped the market into a frenzy: The Netflix share price is up 59% YTD, trades on an 88x earnings multiple and has a market capitalisation of $230bn.

But was that peak Netflix?

While the future remains uncertain, the third quarter revealed a steep deceleration in paid subscriptions, with the company also noting that it expected growth to revert back to pre-Covid levels in FY21.

In Q3 and on a YoY basis, the company reported:

• Revenues of $6.44bn, up 22%. Analysts were expecting revenues of $6.38bn, via Refinitiv.
• Adjusted earnings (EBITDA) of $1.45bn, against diluted EPS of $1.74. Analysts were expecting EPS of $2.14, via Refinitiv consensus estimates.
• Paid net subscription additions of 2.20m, taking total paid net subscriptions to 195.15m. Analysts were expecting net subscription additions of 3.57m, according to FactSet. The company itself had guided for 2.5m net subscription additions in 3Q20.
• Free cash flow (FCF) of $1.145bn.

Netflix management said the reason for the miss on paid subscription additions was due to the dramatically successful first and second quarters which had a pull-forward effect for subscription adds. While this effect is not Netflix-specific – with the pandemic driving a ‘pull-forward’ across many sectors – this effect is expected to impact subscription additions in Q4, with management forecasting net adds of 6.0m in the coming quarter. Should Netflix hit that estimate, the company would surpass the 200m subscriber mark for the first time.

Despite disappointing subscriber numbers in the latest quarter, the company witnessed robust subscription growth and revenue in the APAC region – making up ~43% of the company’s Q3 paid subscription adds. APAC revenue rose 66% during the quarter, with Netflix citing ‘double digit penetration of broadband homes in both South Korea and Japan.’

Citing the uncertainties created by Covid-19, Netflix management further said that we:

‘Expect that our growth will revert back to levels similar to pre-COVID. In turn, we expect paid net adds are likely to be down year over year in the first half of 2021 as compared to the big spike in paid net adds we experienced in the first half of 2020.’

Other bits and pieces: The Q4 outlook

Management guided for Q4 revenues of $6.57bn, implying a growth rate of 20.2%; net income of $615m, and diluted EPS of $1.35.

Elsewhere, the company said it expected its fourth quarter free cash flow to be impacted by the ramp up in production activity. With Netflix expecting productions to increasingly restart, Q4 free cash flow has been guided to be ‘slightly negative’ – resulting in full-year free cash flow guidance of ~$2.0bn.

Though the stock remains overwhelmingly liked by analysts – carrying an Overweight rating on average – it will be interesting to see how and to what degree analysts change their ratings and or price targets in the wake of the Q3.

The current average analyst price target for Netflix is $541.65 per share, according to MarketWatch – implying some upside from the after-hours price levels.

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