What Do You Expect? A few years ago, if you wanted to stream video, Netflix, Inc. (NASDAQ:NFLX) was your only real option. Today, customers can sign up for Hulu Plus and watch television shows the day after they air. Amazon.com, Inc. (NASDAQ:AMZN)’s Prime offers streaming video and free two day shipping. Newer entrants like Coinstar, Inc. (NASDAQ:CSTR) and Verizon Communications Inc. (NYSE:VZ)’s Redbox Instant service are vying for customer attention.
The main difference between these companies is the way they approach the business. Hulu’s main purpose is to drive better viewership for shows on NBC, ABC, and Fox. Amazon.com, Inc. (NASDAQ:AMZN) wants streaming video customers, but is also interested in getting people to buy more from their online selection. Coinstar, Inc. (NASDAQ:CSTR) and Verizon Communications Inc. (NYSE:VZ)’s hope is to sign up customers who will benefit from Redbox’s kiosks and want to stream videos as well.
What Netflix, Inc. (NASDAQ:NFLX) seems to realize is, just buying streaming rights from other companies and trying to get subscribers isn’t good enough. The company basically said they will focus on exclusive content and their “willingness to pay for non-exclusive, bulk content deals (will) decline.” Amazon.com, Inc. (NASDAQ:AMZN) is taking a page from Netflix’s playbook by licensing exclusive content, and looking at original content as well. The question is, what do investors expect from Netflix, Inc. (NASDAQ:NFLX) going forward?
5 Very Important Expectations Going into Netflix’s current earnings, I had an outline of five issues I felt the company would need to address. First, the company’s domestic streaming needs to see continued growth in subscribers, but more importantly contribution profit must continue to increase. The company reported 16.67% year-over-year subscriber growth, but below the 26.4% growth rate last quarter. In similar manner, contribution profit increased 81.94% year-over-year, but this was less than the 109.62% increase last quarter.
The second thing I wanted to see was International streaming showing an increase in subscriptions, and also a lower contribution loss. Netflix, Inc. (NASDAQ:NFLX) delivered on this expectation, with 162% more subscribers year-over-year and a 25.24% improvement in contribution loss.
Third, Netflix needs to see domestic DVD subscriber losses continue to slow. The company also delivered on this expectation, with a 2.92% decline on a linked quarter basis. Considering that last year losses were 9.78%, and last quarter the company’s linked quarter losses were 4.96%, this is a marked improvement.
My fourth issue was, Netflix, Inc. (NASDAQ:NFLX) has shown 3 consecutive quarters of a downward trend in free cash flow. I wanted to see free cash flow turn positive, or at least I wanted to see an improvement. While the company did not generate positive free cash flow, they did break their string of consecutively worse results. The company reported negative $51 million in cash flow last quarter and negative $42 million in the current quarter. This result wasn’t great, but it’s a step in the right direction.
That being said, investors need to have a sense of perspective when it comes to Netflix’s cash flow. Netflix hopes to outspend its rivals on original and exclusive content. The cold hard fact is, multiple of its competitors could outspend the company in a minute if they chose to.
Just for point of comparison, Amazon.com, Inc. (NASDAQ:AMZN) spent $3.7 billion on capital expenditures in the last four quarters. Coinstar, Inc. (NASDAQ:CSTR) and Verizon Communications Inc. (NYSE:VZ) combined spent over $16 billion on capital expenditures in the last year. By comparison, Netflix, Inc. (NASDAQ:NFLX) generated just over $3.6 billion in revenue in this same timeframe. The point is, Netflix can’t hope to match the spending power of its rivals, so the company’s investments need to pay off.
This brings us to the fifth and final issue, the company said they would issue $500 million in new notes, what would they do with the funds? The company expected to spend $225 million to retire older 8.5% notes, which is a smart move. Netflix said they issued this debt because it, “afford(s) us the flexibility to invest in additional Originals.”
What’s Next? The all important question is, what’s next for Netflix? The company is obviously focused on creating original content and becoming more of a content creator rather than just a content distributor. While this sounds good, the company’s strategy could backfire. In two prior shows, House of Cards and Hemlock Grove, Netflix decided to release all 13 episodes all at once. This is great for customers who don’t want to wait for the episodes, but it also defeats the purpose of Netflix creating original content.
Netflix needs to understand that traditional content creators like HBO, NBC, ABC, and others have a reason to create content and not release it all at once. Viewers have to keep watching to see new episodes. If CBS released an entire season of NCIS: Los Angeles all at once, would viewers continue to tune into CBS once they were done watching? Unless CBS constantly generated new hit shows, it’s likely that viewers would look elsewhere.
The bottom line is, Netflix has the ability to be very valuable, if they realize their original content must be released slowly. If they take advantage of their original content in this way, the stock price may be justified. If they keep releasing whole seasons at once, the value of these investments declines dramatically. Not taking advantage of original content could also cause something else to decline dramatically…the stock price.
The article This Company Did 5 Things Right, But Is It Enough? originally appeared on Fool.com.
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