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Did Netflix, Inc. (NASDAQ:NFLX) Really Just Do That?

Netflix, Inc. (NASDAQ:NFLX) reported Q3 data yesterday afternoon. So, how did it go?

The two points we talked about in our preview piece yesterday afternoon (subscribers and international trends) were both home runs. Subs came in at 6.96 mln net adds, which is well above the guidance of 5 mln and the whisper number of 5.4 mln. Domestic subscriber numbers – 1.09 million versus an estimated 0.675 million – handily surpassed expectations, and International (5.87 million vs 4.75 million expectations) knocked the cover off the ball.

Netflix, Inc. (NASDAQ:NFLX) shares boomed higher in response. Helping to push the action, the company also guided much higher for Q4, pushing forecasted new subs up to 9.4 million (versus 7.5 million estimates).

The company now has 130 million paid subscribers up 25% yr/yr. The company forecasted 146.5 mln subscribers to end the year (including free trials).


A Deeper Dive

If there is one caveat in all of this, it’s the fact that management has continually noted that subscriber trends are very difficult to predict. The simple fact that the company did so much better than expectations in Q3 is a testament to this fact. While that’s obviously not much to pick on, it does at least reduce the confidence interval around assuming that guidance is highly meaningful – they could be just as wrong about next quarter, but in the opposite direction.

Again, this isn’t much to pick on. It was another great quarter. And all signs point to a repeat of what we talked about yesterday in our preview piece: the hiccup the company saw two years ago, and the massive acceleration that followed when the market saw signs the train was back on the tracks.

However, it isn’t like there were no red flags. Revenue Growth actually declined to 34% after hitting 40% in Q1 and Q2.

In addition, Operating Margins came in around 12%, which was higher than the 10-11% forecast for FY18. But NFLX did reiterate its guidance for Op Margin coming in at the low end of the 10-11% range. That leads to the inference that we may see a hiccup next quarter in operating margins. One reason that might explain that? The company has started to burn cash a lot faster (burn of $859 mln in free cash, which is the highest number in its history).

That all suggests Netflix is straining to market the heck out of things overseas (that’s where 80% of new subs will come from, at least). But it’s harder to market in foreign countries. The management team is almost all born and raised American. There is an instinctive advantage to playing on the home field.

They are now picking fruit that is a little harder to pull off the stem. Over the long haul, that may well start to figure into how Wall Street estimates the right growth premium for the stock.

But, in the grand scheme, this is not one of the “bad” problems to have for a business. And it will likely take 2-3 quarters of sequential tightening in operating margins to signal a problem worth focusing on for the Street.

At this point, Wall Street loves the stock again. Pivotal Research Group raised their NFLX target to $480 from $435. Needham wrote it a love letter. Cowen raised to $430. And RBC raised to $450.

The stock is currently printing $360, up about 4%.

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