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Netflix - more solid subscriber growth

George Salmon | 18 January 2019 | A A A
Netflix - more solid subscriber growth

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Netflix Inc Common Stock US$0.001

Sell: 361.75 | Buy: 362.00 | Change -8.32 (-2.25%)
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Netflix's fourth quarter update confirms the number of paying subscribers increased 25.9% to 139.3m in 2018. Combined with a 3% increase in average prices, full year revenue rose 35% to $15.8bn. Higher margins meant operating profit rose 91.4% to $1.6bn.

After rising sharply in recent weeks, the shares dipped 3.8% 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. 139m 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 topped $15.5bn this year. Impressive stuff, especially when you consider subscription revenue is by definition very likely to recur year-on-year, so it's hard to dispute Netflix is building a high-quality base.

It should have solid pricing power too. Subscriptions cost around £8 a month, and the average user spends around 10 hours a week on the service. That's about 18p an hour. And with Netflix viewing time still dwarfed by conventional TV, there's plenty of scope to gain further share.

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 is now running well over $10bn a 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.

That spending means Netflix is burning through cash. However, it's been able to plug the gap with affordably priced debt because the market is optimistic it'll be taking in more than it spends in the not-too-distant future. That also explains the shares' premium valuation of 81 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 quarters three and four were strong, a weaker than expected performance in Q2 saw the shares dive.

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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Fourth quarter trading details

Netflix added 8.8m paying subscribers in Q4, well ahead of the 7.6m the group had forecast. Growth was 10.7% in the US, and 39.7% internationally. It expects to add 8.9m new subscribers, with 1.6m in the US and 7.3m internationally.

As expected, group operating margin fell from 7.5% to 5.2% in Q4 due to the timing, and type, of content investments, but still rose from 7.2% to 10.2% for the year as a whole. Next year, the group expects to deliver a margin of 13%.

Investment in new content like Bird Box and Narcos totalled $13bn over the year, leading to a free cash outflow of $3bn. That's at the low end of previous forecasts. Looking ahead, Netflix expects to report a similar outflow next year, with incremental improvements in the following years.

During the quarter the group confirmed plans to raise prices for customers in North America and Argentina, and appointed a new CFO, Spence Neumann.

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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 disclosure for more information.