Netflix (NASDAQ:NFLX) will release its Q1 2014 earnings on April 21, given the recent performance of the stock, the earnings will be under watchful scrutiny. Last month, we wrote an analysis talking about the disconnect between the company’s business fundamentals and its market value (read Numbers Show A Disconnect Between Netflix’s Market Valuation And Business Growth Trajectory). The stock has fallen by 25% since, as the market corrected itself after the exuberance that followed its Q4 2013 results. As we look forward to the first quarter results, we also take a cautious view. While the results are likely to be strong, growing competition and rising costs warrant a higher risk factor for Netflix’s stock. We believe the market is also aware of this.
Our $250 price estimate stands at a discount of about 25% to the market.
The Outlook For Q1 2014
Domestic Streaming: The mid-point of guidance suggests that Netflix expects to gain roughly 2.25 million net domestic streaming subscribers, which is slightly below the figure for Q4 2013. [1] However, that’s expected as the first quarter tends to be seasonally weaker. In addition to this, the company expects its first quarter revenues to be around $798 million, registering a growth of 24.5% over Q1 2013 and 7.4% sequentially. [1] Domestic streaming contribution margins are also likely to continue the trend of sequential improvement and could surpass 25%. [1]
International Streaming: Netflix expects to add 1.6 million international members, slightly below the figure for Q4 2013. [1] This is a little surprising as we didn’t expect seasonality to kick in so early in Netflix’s international operations. The impact of seasonality becomes more prominent as the business matures, but the company has a lot of potential to expand overseas. We’ll be carefully watching how its subscriber base in Europe, Canada and South America grows over the next couple of quarters. On the plus side, international streaming contribution margin are expected to improve to -15.7% as compared to -25.9% in Q4 2013. [1]
Growing Costs Are Something To Watch Out For
One of the primary concerns that Netflix faces is rising content costs as its off-balance sheet content obligations have surpassed $7.25 billion. However, the company has been able to grow its contribution margins by expanding its user base and gaining operating leverage. Growing competition from Amazon and possible challenge from Apple (AAPL), could slow down the growth in Netflix’s customer base and content costs as a percentage of revenues can go up. Additionally, with competitors bidding on the same content, Netflix may have to shell out more money. None of this is favorable for the company. We currently forecast domestic streaming contribution margins to grow from 24.9% in 2013 to over 37% by 2020. However, there can be a downside of about 12%-15% to our price estimate if the figure was to increase to only 30%. But these are not the only costs that Netflix needs to worry about. Recent developments suggest that it may have to spend additional amount to ensure good streaming standards in future, especially as the video quality increases, which in turn will require data transfer at a higher bit rate.
Notes:
- Netflix’s Q4 2013 Letter to Shareholders
Disclosure: No positions
