Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Netflix, Inc. (NASDAQ:NFLX)

JPMorgan Global Technology, Media and Telecom Conference Call

May 20, 2014 10:40 AM ET

Executives

David Wells - Chief Financial Officer

Analysts

Doug Anmuth - JPMorgan

Rod Hall - JPMorgan

Doug Anmuth - JPMorgan

All right. Good morning everybody, my name is Doug Anmuth, Internet Analyst here at JP Morgan. It’s our pleasure to have Netflix's CFO David Wells. So Netflix world's leading internet subscription service for movies and TV shows. Company has about 36 million streaming subscriptions in the U.S. 13 million internationally and 7 million DVD subscriptions in the U.S. David has been CFO since December 2010 and prior to that head of FP&A. So, welcome David, thanks for being here.

David Wells

Thanks Doug.

Question-and-Answer Session

Doug Anmuth - JPMorgan

So, let's get into some sort of general questions first, but so Comcast, Time Warner cable, AT&T Direct TV, what is negative consolidation in the multi-channel space mean for Netflix?

David Wells

On a video buyer basis, they have greater scale, so it's going to be more leverage brought to there on their carriers negotiations. But I think for us, we are mostly concerned about consolidation on the broadband side, not necessarily on the video side.

So, we'll read the formal filing on Direct TV, AT&T, so won't say much there. But there was a mention of rolling out additional 15 million broadband household that would be a plus for Netflix I think. On the Time Warner cable side, Comcast side, we're mostly concerned with the fact that cable modem is a dominant technology in the provision of internet services and it's not equivalent competition for DSL and other things.

So, when you combine that dominance in the technology with the perspective to have 60 million pass broadband households, you combine scale with dominant technology and you get concerned about concentration of market power there.

Doug Anmuth - JPMorgan

Okay. How do you think about Netflix [System], both in the U.S. and overseas over the next five years? Why is 60 million to 90 million subs in the U.S. potentially achievable?

David Wells

Well, I don't think -- so our point of view hasn’t changed on that. We still think 60 million to 90 million is the right addressable market for us. We think those, that defines to set of folks in the U.S. that would be interested and able to pay for our service. And you get there a number of ways you've got 30 million households for HBO or thereabout in the U.S. for a non-direct product to consumer, they're at a much higher price point, we offer a lot more content for our service at the $9 level. And we are direct-to-consumer so we feel like with the direct product there would be a much bigger subscriber level and Netflix would be able to address that market.

The other way you would get there is looking at pay television households and thinking about 90 million to 100 million of pay television households. This just defines a set people that pay every month $40 plus for video services, so they're interested in video, they are able to pay for it and we're able to provide the superior aspects on demand with a great content set.

The other thing I will point out in the, when you look at our long-term letter which this is sort of laid out. I would say, we also intend and expect to continue improve our service, so you've seen a better product over the last year, which is much better in terms of content, it's much better in terms of the way it look and feel and the way it performs across devices and is delivered than it was two three years ago. And I would expect that rate of improvement to continue. So we'll continue to add content originals is a big piece of that. So we're excited about what we can do over the next couple of years.

Doug Anmuth - JPMorgan

And then just taking that over to the international markets. What types of overseas markets do you think work best with your model and how do you think about the global TAM sort of in relation to HBO’s around the 114 million global subscribers I believe?

David Wells

Overseas markets, it’s not a shock that what might work best is again the ability and interest; ability to pay and the interest in entertainment. So you look at large developed media markets and there is a huge demand for western and Hollywood produced content, you can drive that through what their incumbent MVVD players pay and license in the market. You can drive that through piracy, you can drive that through consumer expectations of what to watch and the social media graph on particular titles and shows. So we have a pretty good -- we have pretty confidence that there is demand for a product like Netflix in many additional markets that we are not in today. So broadband penetration, the usual suspects would apply broadband penetration, wealth levels, the e-commerce ecosystem and the smoothness and frictionless obtainment all of those apply.

Doug Anmuth - JPMorgan

Okay. You recently announced the pricing increase, so in the U.S. $1 for new members with existing members being grandfathered in. How do you think that’s been received by consumers so far? Are you sensing any kind of change at all in terms of the brand?

David Wells

Well, it’s pretty early, it’s 11 days, and I think we have learnt to season our conclusions a bit. But I would say it’s generally as expected. We were somewhat pleased, we expected a small reaction and I think we’ve gotten that so far.

Doug Anmuth - JPMorgan

Okay. And how has the price increase been rolled out differently across different markets, sort of the amount of increase, the grandfathering, time frame, what’s the thought process that’s gone into that?

David Wells

So generally grandfathering is consistent across all the markets. We have -- there is a small exception with high inflation markets like Brazil where the period of grandfathering is reduced to a year versus two years. But generally I’d say, that is consistent across the world.

In terms of the pricing, again the introduction of a third tier because we had -- we had two offerings before the U.S., we introduced a third. I would say we’ve done that consistently across the globe as well. So there is some mix in terms of whether or not we raise the two stream plan and we will see -- we will learn from that in some markets in terms of the elasticity as well as the substitution for the one stream plan.

Doug Anmuth - JPMorgan

And then how should we think about the pricing upside falling through the model? I mean would you like more flow to the bottom line or you are taking this and sort of investing in additional content?

David Wells

I think -- the aspiration is to do both. So we have been able to grow as we grow members, we have been able to grow margin and grow content and we would like to continue doing that. As our average subscription price increases, as the price increase sort of rolls in slowly for new members and as grandfather members come off, we would look to put more to content but also to allow some margin expansion as well.

And we have committed to 400 basis points in the U.S. improvement up to 30% and we have given ourselves sort of the latitude to step back and look and think strategically about the next five years and what’s the right level of content investment from there.

Doug Anmuth - JPMorgan

And what’s significant about 30% level for you?

David Wells

There is nothing magical about that number, it’s conveniently even. And we think that we can hit that over the next four quarters or so. And it’s just an opportunity to step back and think about it. It also gives us enough time to seizing the price increase and the mix and help people accept sort of the one stream, two stream, three -- four stream plan. So we'll have a little bit better indication of what our ASP might look like down the road.

Doug Anmuth - JPMorgan

Okay. And how should we think about the domestic streaming growth across both gross adds and churn? Do you feel like one is currently stronger, a stronger driver than the other and how could that change as you move toward that potential goal of $60 million to $90 million.

David Wells

Well, I think they are equally right, contributors to net additions is kind of a mixtures, sometimes it's hard to know whether somebody is a churn or not. So, I would say as we get bigger and bigger and the prospect of saturation takes hold, obviously churn becomes a little bit and retention become a little bit more important versus adding new subscribers to the service.

But right now we're still in the mode where we're pretty comfortable that there is equal contributions there.

Doug Anmuth - JPMorgan

Okay. And we often get the question of how many cumulative subscribers Netflix has had overtime? How many people you have touched, is this even do you know first of all? I mean is this even a relevant metric?

David Wells

It's not really a relevant metric, I would say sure we have some indications, but people change their emails all the time, it's pretty easy, there is data rules around retention of how long you can keep a subscriber’s email.

So, you've got a good indication of one year and two year period, but after that it's a bit hard to know. It's not something we regularly look at.

Doug Anmuth - JPMorgan

Okay. All right. And then moving over to the international business, what surprised you most about the international roll out so far?

David Wells

Surprised me most. Well, I guess there is a little bit of surprise in our ability to compete in an already sort of first in market in the UK, very competitive market. We have been able to grow, we are pretty happy with the trajectory and our content offering in the market and we continue to better that content offering. So if there is any surprise there it might be the ability to compete in a very competitive marketplace.

Doug Anmuth - JPMorgan

And which existing markets do you feel like you’ve more work to do?

David Wells

Obviously all of them, even a place like Canada which is the most mature market for us. We still intend to better the content, better the device experience, better the streaming delivery experience all of that. I mean we still have, we feel like there is plenty of room for improvement to get that level of delight and experience to our members to something that would even wild and even more in the next couple of year. So there is not any one market that we feel like that we're done.

Doug Anmuth - JPMorgan

Okay. And you've talk about a heavier European expansion in the back half of this year. How many markets individual markets are we talking about and how should we think about the degree of costs and spending associated with those launches?

David Wells

Such a [tease] that we still having confirmed everything here, but we will over the next three weeks, a few weeks I should say you probably get a conformation, it's likely that you will get a conformation, there is plenty of speculation I'd say, I'll leave it with the language we had in the lever which is around a substantial expansion in Europe and I will leave it there.

I'd say just in general on the international addressable markets one thing it did really hit in your first question. There is about 700 million broadband households depending on whose survey using and how you counted in the world. If you take a 100 of them or thereabout is out for the U.S., you've got 600, if you take another 200 or so out for China, you kind of carve that out on its own market. What you left with is Netflix is addressing about anywhere from a quarter to a third of that market. So we've got that much more that we think that we could address and that might include some markets that are a little bit more oriented towards local content, but there is plenty of expansion markets that we feel like Netflix would be a viable product to.

Doug Anmuth - JPMorgan

Okay. And just going back to the second part of my last question, how do we think about costs and spending, right? I mean can we think about sort of the next few markets and use the ramp up cost that you had in previous international markets sort of as a proxy for the degree of spend?

David Wells

You can. So when you think about…

Doug Anmuth - JPMorgan

[Beginning, right]?

David Wells

I would say it’s the two biggest cost or content in marketing when go into a new market, marketing tends to peak in the first quarter because you are opening the market, you are building a brand from scratch or building awareness from scratch and then it sort of settles out I would say the content is very dependent on the characteristics of the individual territory, the more competitive the territory, the more expensive the content. Some of the illusion to your question since we are later in the game of world competition for OTT video or is the content wretched it up, not necessarily, it really does depend on the territory, there are some markets where the incumbent players maybe trying lock rights and other things but what I have learned over the last two to four years is it’s extremely difficult to suck all the content oxygen out of the air of a market, there is a lot of content. We have entered markets before where there is certain content that has been locked up or not available or “too expensive” and we’ve been to compete and add things on the margin and then suddenly something unlocks. So again it’s about continuous improvement of your offering and I think that we are still in a position where we feel like we have a very competitive offering.

Doug Anmuth - JPMorgan

And you said your existing international markets will all be profitable by the end of ‘14.

David Wells

Yes, we have a good chance to do that like on a consolidated basis, on a consolidated basis.

Doug Anmuth - JPMorgan

So equates to that all the existing collective other than each individual market?

David Wells

Yes.

Doug Anmuth - JPMorgan

Okay. But with those markets, should we expect any sort of significant reinvestments in content or marketing; is there any chance that that can go backward over the coming quarters after the end of ‘14 or is it just you get the scale and….

David Wells

Less likely, so I think our intent like the U.S. is to continue to grow content but also to grow margin. So to grow content spend slightly slower than revenue, I will put a caveat in here for us like I have on the U.S. before which is look we are committed to margin expansion but we are also committed to while we are growing but we are also committed to making a great long term product. And if we think opportunistically something comes along or that we get creative on some piece of content and that’s the right decision, we are willing to have margin flat for two or three quarters and do something that is going to strengthen our content offering.

Doug Anmuth - JPMorgan

And can you launch in such international markets without the rights to some originals for example like House of Cards or other shows, other originals?

David Wells

Sure. I think the concept early on in our originals days, we didn’t necessarily wanted pay the full opportunity cost to lock up the world on every original. I’d say you should expect us to not have 100% in every market but that goes away over time, and we will have meaningful originals in each market.

Doug Anmuth - JPMorgan

Okay. What are you most excited about in terms of new content in the upcoming quarters?

David Wells

The breadth of the content is going to expand a little bit for us. I think you’ve heard me mention before that we have intentionally chosen sort of certain genres to provide a greater range of originals to our subscribers. And I think what you'll see is we're going to experiment with BoJack Horseman, which is a animated show targeted for older people. When I say adult, it doesn't quite come across right. And so that's a think of a family guy at the greatest aspiration level there. So that might be really interesting. Those are high variability in terms of outcome, but that could be great. I think personally I'm excited about Marco Polo which is a show that chronicles the journey of Marco Polo. It’s shot in exotic locales, there is a little bit of Kung Fu woven into it, Martial Arts. So, it's got the action angle, it's got the exotic locale going, it's a good -- it's got a drama angel too.

Doug Anmuth - JPMorgan

Okay. Did you have the opportunity to bid on HBO content? What are your thoughts on that deal for Amazon and how it relates to Netflix?

David Wells

So no, we didn't bid on it. To my knowledge they didn't shop it. And I would say, it's good older content with some conspicuous absences in the title list that solves the problem for HBO, they probably were not getting a lot of HBO go traffic on those catalog titles and they need to reach sort of [code never] market. So, I would say that that was probably a good deal for them.

Doug Anmuth - JPMorgan

Okay. We think you will spend around $3.2 billion in streaming content this year or a number?

David Wells

Global.

Doug Anmuth - JPMorgan

Global. Thank you. And you are approaching or surpassed HBO levels of spend. How do you think about how much more content spending is needed to continue to grow the base and how that trends over time?

David Wells

Well, we offer a lot more breadth of content than HBO. So, it’s a little bit of a apples to oranges comp. I would say our intent is to continue to expand the content library. If we're going to meaningfully address the $60 million to $90 million, we'll need to do that by adding more originals, we'll need to do that by adding more breadth of content. And part of that is making our content more exclusive, so moving it from non-exclusive to exclusive and offering more curetted offerings, meaning a little bit less [depth] and a little bit more four, five star content.

So we intend to, as we grow, to continue to grow our content and we'll grow that slightly slower than revenue so that we can expand margin. But I would say, there are still great content out there when we add new deals, we still see expansion of our [view], meeting our [view], so it's indicative that we're not just substituting content and we'll be paying attention to that each time when we're looking at new content that comes in whether that's at a deal level or at a title level.

David Wells

Okay. If the people in the audience have questions feel free to head over toward the mics and we'll take some of your questions. You can do one from there, I'll repeat it.

Unidentified Analyst

(Inaudible).

Doug Anmuth - JPMorgan

Question is just around capacity needs for pipes going forward.

David Wells

So there is plenty of capacity in the technology and the belief in sort of Moore’s Law improvements across each aspect of that delivery chain whether that's the data center assets of the cash boxes, the storage, the processing power in the data center, the fiber optic utilization, the compression technology, all of that will improve over time. In the deals that we've done sort of in the mid-term with Comcast, Verizon, we’ve accounted 404k and other things in terms of being able to grow with that. And so, I think we feel pretty comfortable about the ability to deliver.

Unidentified Analyst

(Inaudible).

Doug Anmuth - JPMorgan

Question is why outsource the Amazon and is that going to continue going forward?

David Wells

So, you are referencing use of Amazon web services and the cloud architecture that we have. Do we expect that to continue? Absolutely, there would be tremendous capital investments if we were to build out data centers across. So I think we were very pleased with the choice of going with the cloud architecture and Amazon is a very strong lead in that market. And we have to-date been exceptional partners with each other there. We don’t have the fear that because they compete head-to-head with us on the video side that they will suddenly turn nasty as AWS or cloud provider. There is too much at stake for them in terms of the viability and the reputation of that business. So, we expect to continue to be great partners together and we help push them to have a better product and they help push us in terms of the ability to scale our network very quickly and efficiently.

Unidentified Analyst

(Inaudible).

David Wells

Not, right now. The question was do I ever think there is a point that we do something like that on our own. Right now, I don’t think the economics works, and I am not sure I’d see that.

Unidentified Analyst

And David, what are your latest thoughts on the SEC’s recent efforts around net neutrality?

David Wells

Yes. I mean there is a little bit of a complicated one in terms of there is three different answers, aspects of net neutrality. I would say a little bit disappointed and I know Chairman Wheeler is in a tough position, he is trying to sort of take for the time from what Commissioner [Janikowski] did. I think at this point they are just trying to reinstate the rules that we are satisfied by the Verizon challenging that in court, I think he is referred to blocking and discrimination as one thing and the [paid pairing] of the arrangements paid interconnection with Comcast as a first cousin. I would say if they are first cousins, they are bit like 18th century royalty cousins, they may have had a child somewhere around the way. And I would say just in general our interest is in definition of net neutrality that is inclusive of all things that matter towards the delivery and the ability to control that interconnection with the consumer as an ISP. And our positions is pretty plain, we have been out there on a blog and we have been out front in terms of taking the position both as an internet content company and as on behalf of consumers, and again back to my segment earlier of being concerned about the lack of competition in a market combined with scale and being little bit concerned about what happens there.

Doug Anmuth - JPMorgan

And that refers to the high speed lane potential?

David Wells

Yes, it does. If you had competition, I am not sure that you would have the ability to toll the content provider.

Doug Anmuth - JPMorgan

Okay. Go ahead.

Unidentified Analyst

This morning, in the Verizon presentation like Adam said that he thought that there was getting to be a lot of emotion around this net neutrality and that in particular when it’s connected to your agreements with Comcast, he sees that just as another carrier agreement and nothing to do with net neutrality. You want to comment?

David Wells

Well, I would say, how can it not have -- how can it be nothing to do with net neutrality when it still affects the ability to access content in a manner that's consistent with what you're paying the ISP for? So, I guess I would respectfully disagree.

Doug Anmuth - JPMorgan

And how long are those hearing agreements with Comcast and Verizon, we've seen a Comcast performance in your monthly index has improved pretty materially over the last couple of months, any reason to believe that Verizon wouldn't see the same thing?

David Wells

No reason to believe that that won't improve for Verizon. We haven't been specific about the [De Link]. I'd say that the long-term is what does debate us about and the deals don't cover 20 year. So this isn't a 20 year deal.

So, it's about the long-term and the competitive dynamics of internet provision in the long-term and what that does with content companies?

Doug Anmuth - JPMorgan

Okay. Other questions from the audience? I have one and this has been emailed to me which is if you could talk more about the difference in structural margins for the international markets versus the U.S.?

David Wells

Well, there is no difference in structural margins for an international territory or investments in the U.S., almost the same. The big investments are content and marketing or expenses, if you want to think of them that way. And I would say there is no reason to believe that in territories outside the U.S. we can't get to equivalent margins.

I think maybe the question is also referring to sort of at that the operating level. So we meaningfully talk about contribution profit which is our revenue minus content minus marketing. What’s left out is our global technology and development spending that we have a global product, we don't have individual territory tech teams.

So, at that level I would say our technology and development, we intent to sort of scale that with or slightly slower than revenue and same with G&A.

Doug Anmuth - JPMorgan

Okay. Can you talk a little bit about your set-top box, your agreement sort of through the middle of deals ones that you have in Europe and then you've also recently announced or perhaps already started with some smaller MSOs in the U.S.?

David Wells

Sure. That was very recent, right. So the smaller MSOs in the U.S. through their tether box; we have liked what we've seen and I think Virgin has as well in the UK. We have done since smaller MVPD or MSOs in Nordics with [Wahu]. And so I think what you've seen is similar to three, or four years ago on the content side that relaxing of the concerns and anxiety around doing business with Netflix is starting to be a little bit relaxed on the MSO side. I think for most of them, they would much rather have their video subscriber or their subscriber stay in their ecosystem than they would to start losing them. And certainly if I'm in their position and I'm looking at the data of how many folks turn on their cable box and they stayed or their satellite box and they stay in my ecosystem and then look at pay per view activity and things like that, I wouldn't want to be losing that pay per view activity to somebody else, because that’s sort of -- you could hypothesize that's the first step to them not meeting you.

Doug Anmuth - JPMorgan

And then just back to content permanent. Do you want own content outright and control full distribution going forward, how do you balance the benefits and the risks there?

David Wells

Well, I think what you just said is the most important, the latter; the control it's what's important not necessarily the ownership, most of the time control is affected to ownership. But if we can gain control to a long-term first window license we will do that too. And so what’s really important is a very long-term control of any exclusivity of that license. You will see us experiment with ownership. We’ve done certain originals to-date. All of them have -- the common aspect is that long-term license period, but fully expect us to have owned models. And then the difference in the risk, I think early on we had an appreciation that was less risky to own; now we have a better appreciation that you can always deliver the content which then makes you obligated at the license line, and would you rather have more control over the creative output and the outcome of that absolutely. And we have very much sort of stayed side by side on the creative projects that we have done even the ones that we don’t own. So it’s just a slight evolution of what we are doing already.

Doug Anmuth - JPMorgan

Are there other questions, one in the back, could you just come to the mic? Thanks.

Rod Hall - JPMorgan

It’s Rod Hall with JP Morgan. I am the networking analyst. I just wanted to ask you real quick. If you could talk about the -- I know you guys have trialed UHD streams, some of the higher bandwidth streams and also maybe a little bit of 3D content. Could you talk about what proportion of your subscribers you can reach with that content today, given the way the networks are structured? And whether you need to see further investment over time to reach more people with that kind of content? And I might have a follow up to that.

David Wells

Well, it’s early days on all that, so I would say that it’s a fraction of very -- of early adopters that avail themselves of the ability to view that content and it will steadily grow overtime. We’ll put more and more into it, so again early days there. But we don’t feel network constraint; I don’t think at this point, I think it’s the content building slowly in terms of both resolution, color depth and frame rate that’s the -- you put the packets together and you get the next sort of content evolution at least terms of -- from a consumer perspective. I think it’s generally shortcut, it is 4K, but there is aspects of frame rate and there is aspects of color depth as well that might be in that next generation of experience.

Rod Hall - JPMorgan

Do you need a cable or fiber access plant in order to deliver those kind of streams or do you think DSL is fast enough to be able to deliver the stream that you’d like to be able to look at?

David Wells

You are asking the finance guy. But I would say to-date we haven’t seen network constraints on that.

Rod Hall - JPMorgan

Great, okay, thank you.

Doug Anmuth - JPMorgan

Other questions? Not to [move] toward association (indiscernible). All right. let’s do that. All right. So first thing that comes to your mind, House of Cards?

David Wells

Awesome.

Doug Anmuth - JPMorgan

Comcast?

David Wells

Complicated.

Doug Anmuth - JPMorgan

Churn?

David Wells

Over ask.

Doug Anmuth - JPMorgan

Churn? FCC?

David Wells

Complicated.

Doug Anmuth - JPMorgan

Germany?

David Wells

Big media market in Europe.

Doug Anmuth - JPMorgan

AT&T?

David Wells

A partner.

Doug Anmuth - JPMorgan

Disney content?

David Wells

Great. We’ve got catalog content, I know you don’t like the more than one word answer and we’ve got the new [pay one movies] that will come later on…

Doug Anmuth - JPMorgan

When will this hit?

David Wells

Good partner. Into ‘16 and into 2017 is when our first starts to flow.

Doug Anmuth - JPMorgan

Seasonality?

David Wells

Present, still there.

Doug Anmuth - JPMorgan

Orange?

David Wells

June 6th.

Doug Anmuth - JPMorgan

All right, good. We'll leave it there.

David Wells

Awesome.

Doug Anmuth - JPMorgan

Thank you. Great.

David Wells

Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Netflix (NFLX) Presents at JPMorgan Global Technology, Media and Telecom Conference (Transcript)
This Transcript
All Transcripts