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Netflix - subscriber growth drives box office results

George Salmon | 17 October 2018 | A A A
Netflix - subscriber growth drives box office results

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Netflix Inc Common Stock US$0.001

Sell: 496.88 | Buy: 497.27 | Change -0.09 (-0.02%)
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Netflix has reported third quarter net customer growth of 6.96m, which comfortably exceeds previous guidance for around 5m. This takes the group's subscription base to 137.1m, or 130.4m excluding those on free trials.

Fourth quarter net additions are expected to be around 9.4m, or 7.6m excluding free trials. That's also ahead of previous expectations.

The news sent the shares up 11.6% in after-hours trading.

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Our view

Video killed the radio star, and Netflix is looking for cable's crown.

The way we watch TV is changing and Netflix is leading the on-demand revolution. Over 130m viewers are already signed up, and the customer base is growing fast.

Rapid growth means revenue has been something of a blur. After posting $4.3bn in 2013, it should top $15.5bn this year. Impressive stuff. And when you consider subscription revenue is by definition very likely to recur year-on-year, it's hard to dispute Netflix is building a high-quality base.

We think it should have solid pricing power too. Subscriptions cost around £8 a month, and the average UK adult spends around three and a half hours a day watching TV. For a couple, that works out at £0.04 per hour each.

Of course, there are others looking for a slice of the action. Pretty powerful players too. To fend off competition from Amazon and Disney-backed hulu, Netflix is splashing out.

Spending on marketing and content will add up to approximately $10bn this year. This includes making Netflix originals - think House of Cards, Glow and Ozark - and licenced content from other production houses. For example, it's recently agreed a deal with ITV Studios for the non-UK rights to hit drama Bodyguard.

As Netflix leverages the benefits of its newfound scale, there's clear potential for profitability to improve. Analysts expect operating margins to hopscotch from 7.2% in 2017 to 10.5% this year and 13.3% the year after. The double win of higher margins and revenues explains the shares' premium valuation of 86 times expected earnings.

So far Netflix has generally delivered the growth that high rating demands. However, the pace of expansion from quarter to quarter has proven difficult to forecast. While Q3 surprised on the upside, weaker growth just three months earlier brought an equal and opposite reaction.

While Netflix is making a strong case for best newcomer, the industry is still in its early days - that's both an opportunity and a risk.

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Third quarter trading details:

Subscriber growth was broad-based, with net additions rising 1.1m in the US, and 5.9m internationally. That sharp growth, combined with an 8% increase in average prices, drove Netflix's third quarter revenue up 34% to $4bn.

With operating margins rising from 7% to 12%, quarterly operating profit rose from $209m to $481m. However, the group was careful to point out Q3 numbers benefitted from some content spend shifting into Q4. With spending set to rise in the final quarter of the year, Netflix still expects operating margins to come in at the lower end of the 10-11% range.

In Q3 Netflix rolled out its first mobile bundle in Japan, and agreed a deal with Verizon for the Netflix app to be pre-installed on Android phones. In Q4, a partnership with Sky TV, which will see the offering rolled into a subscription bundle, is due to launch.

While free cash flow was negative at -$859m in the quarter, the higher content spend in Q4 will likely see this outflow increase to over $1.3bn. That's because year to date outflows sum $1.7bn, and the group expects the total for the year to be 'closer to $3bn than $4bn'.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.