Netflix, Inc. (NFLX) Earnings Are Bad, But The Long Term Is Even Worse

Netflix, Inc. (NFLX) Earnings Are Bad, But The Long Term Is Even Worse

Netflix, Inc. (NASDAQ:NFLX) reported third quarter earnings after the closing bell. The company disappointed investors with revenue of $905 million, and EPS of $0.13. Analysts had been expecting EPS of $0.05 on revenue of $905 million. Shares of the stock are currently down 15% in after hours trading. Shares of Netflix, Inc. (NASDAQ:NFLX) were down close to 20% right after” the company released results.

Q3 DOMESTIC STREAMING NET SUBSCRIBER ADDITIONS for the company came in at 1.16 million. The company sees Q4 DOMESTIC STREAMING REVENUE at $581 million to $588 million.   International expansion hurt the company’s gross margins. The company states that  they expect international losses of $113 million in Q4.

We focus on the long term picture. Morgan Stanley is out with an interesting report today. We summarize their points below:

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A comparison of Netflix, Inc. (NASDAQ:NFLX) vs. the pure play cable nets reveals starkly different returns on content investment. There are multiple reasons for the gap in profitability, including the impact of being inside or outside the pay-TV “tent”.

What’s wrong with this picture? The picture below shows the ratio of enterprise value to content spend for Netflix, Inc. (NASDAQ:NFLX), Discovery Communications Inc. (NASDAQ:DISCA), Scripps Networks Interactive, Inc. (NYSE:SNI), and AMC Networks Inc (NASDAQ:AMCX). On average, the market values cable net assets at ~20 times their ‘12 spend vs. ~2 for NFLX. Looking simply at domestic EBITDA margins, the average basic cable network has a margin of ~50% vs. Netflix, Inc. (NASDAQ:NFLX) at ~10% (excl. DVD). Finally, in absolute dollars Netflix, Inc. (NASDAQ:NFLX) spends more on content than DISCA, Scripps Networks Interactive, Inc. (NYSE:SNI) and AMC Networks Inc (NASDAQ:AMCX) combined.

Business models matter: Netflix, Inc. (NASDAQ:NFLX) is an entirely on-demand retail service, while cable networks are sold wholesale to distributors and benefit from monetizing repeats. We estimate that less than 10% of the hours aired during the year on these cable networks are “new”. Netflix, Inc. (NASDAQ:NFLX) needs to continually supply its customers with new content or face escalating problems. Churn for basic cable nets is a non-factor, as they do not incur SAC and distributed irrespective of platform (cable/telco/sat).

Is Netflix service too cheap?

With ~$2bn in content spend in the US, the service is underpriced at $8. Morgan Stanley believes that the profit maximizing strategy is to raise rates, rather than go for sub growth. Is Netflix, Inc. (NASDAQ:NFLX) over paying for content? Quite possibly. The recent decision to let Epix go non-exclusive to, Inc. (NASDAQ:AMZN) for ~$50 mn suggests a paring back of spending.

Are cable nets over-earning?

Long-term  they see risk. Content expense across these companies is up ~15% p.a. since ‘09, and we recently increased estimates for ’13 spend for Discovery Communications Inc. (NASDAQ:DISCA) and Scripps Networks Interactive, Inc. (NYSE:SNI). Competitively, each faces restructured broadcasters benefiting from new re-transmission fees, emerging online players, and potential audience erosion from greater time shifting.

Disclosure: No position in any securities mentioned