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Will Netflix Beat Earnings Or Will Japan Pull Them Down?

I’m going to do a quick analysis of Netflix and here is a tip on how you can analyze your own company:

Google: “Company name” investor relations, and you will see the company’s investor relations site. This is a gold mine for a dedicated fundamental investor.

Look for their previous quarterly earnings and see if they have a deck (it’s the easiest to find important data) othervise look for their press release. They usually do a forecast for the upcoming quarter, here is where you find the “thesis” which you will evaluate your findings towards. If you read in the summary of their report they often talk about their most important metrics.

In my case I’m looking at Netflix, who are relying on their subscriber growth as a key driving metric. Below are their forecast numbers (Q3’15):

Netflix q3 forecast

Source: Netflix

If we’re looking at the memberships we can see that they predict total memberships to grow from 42.3 million to 43.45 million in the US and from 23.25 million to 25.65 million internationally. That is 1.15 million (2.72%) growth in the US and 2.4 million (10.3%) internationally.

This gives us the first thesis: Will Netflix grow their total user base with 3.15 million members? (I will only focus on this one in this blog post but you can do multiple ones).

Now that we have the thesis that will drive the stock price up or down, it’s time to do some research.

User Growth Research

What are some growth levers that Netflix has pulled this quarter? Last quarter they saw the full effects from their new markets.

Our international segment is growing at a rapid pace. We did not add additional markets in Q2 but saw continued improvement across existing markets, including a full quarter of additions from our successful March 24, 2015 launch in Australia/New Zealand. We project Q3 international net adds of 2.4 million.

For this quarter the only new market is Japan, so we have to look at that as our lever plus the growth from existing markets. Let’s dive in!

Global Interest Over Time

Google trend is a really cool tool to see what people are searching for. Here we can see that the average search score for Netflix was around 70 between April and June (Q2), for the latest quarter you can see a average of 76 an increase of about 9%. So how much does this score mean? HBO, which was said to have become a competitor to Netflix, had a search score of around 7 during the same time. Let’s take a look at the regional interest for the last 18 months:

Regional Interest Over Time

Interesting movers are primarily Central and South American countries, this could be due to their release of Narcos. Looking closer at Brazil and Mexico, Netflix’s third and fourth largest markets, you can see search growth of +16%. Given that the conversion rate (number of searches that turns into memberships) stays the same, we could see a 16% acceleration in the membership signups in those areas and similar in the rest of South America. The next interesting market is Japan, which only had 28 days to contribute subscribers to Netflix.

New Markets – Japan

Netflix knows that Japan is a hard market to penetrate, so they partnered up with SoftBank to get access to their 37 million subscribers.

The Google trend for Netflix in Japan looks like a boom and bust, especially when comparing to Tsutaya, GyaO, and Hulu who are already in the Japanese streaming market. So the question is how many Japanese subscribers could Netflix have converted during 28 days in September? Australia garnered about 300k subscribers in April, that’s a 3.3% penetration of the 9 million households. Japan is going to be much harder, It took Hulu 4 years to reach 1 million subscribers in Japan. Just from looking at the search activity my guess would be 50k – 90k new members in Japan for the first 28 days.

These two observations gives opposing views of the subscriber growth. So which one has the largest impact? Last quarter, my guess is that about 500k subscribers came from Australia and New Zealand and 1.87 million international growth came from elsewhere. If Japan is a flop Netflix needs 2.4 million subscribers from the rest of the international market, that is a 28% uptick in the quarterly user growth. I can see a 15% – 20% uptick with the South American growth, but 28% could be hard.

The market is bullish though,

In a research earlier this week, Michael Nathanson, media analyst at MoffattNathanson, said Netflix could add 4.2 million new subscribers, including 1.5 million domestic and 2.7 million international, which would bring the company’s total paid subscriber base to a record 67 million. – According to CNBC

Looking Closer at The Numbers

If we look at it from a pure math standpoint we can look at the member growth in correlation to search. Just kidding, I’m making it easy for you guys and use graphs instead.

Search to members

Source: SprinkleBit

A pretty nice correlation there, the causation doesn’t actually matter in this case as we already have the Q3 search data, we’re just trying to figure out the member growth and that will be easier if we look at the growth rates of this graph.

Search to members growth

Source: SprinkleBit

From this graph we can see that there is a somewhat delayed reaction in the user growth rate compared to the search growth rate.  The search volume had a growth rate of 2.3% previous quarter and a 9.2% this quarter. In order for Netflix to hit their target they would need to bump up their quarterly growth rate from 5.3% to 5.4%. It looks like a no-brainer but this would be without the 0.8% (500k) contribution from new Aussie subscribers. So really what we are looking for is a 0.9% uptick in user growth to cover for the the Japanese slow growth. If one accounts for the average search to member growth we would see user growth of 7.3% which is highly unlikely considering the increased maturity of their markets but it also fortifies that a 5.4% growth rate is clearly feasible.

This can only lead to one conclusion; Narcos

From looking at the search score we can see that Narcos drives more traffic to Netflix than Japan.

Rising searches for netflix Search Score Growth
narcos netflix 4 450%
narcos 4 400%
pablo escobar 1 900%
netflix pablo escobar 1 700%

Considering that the series is primary in Spanish and their lead actor is Brazilian this could explain the +16% increase in search traffic to Netflix, and if there is a 1 to 1 correlation between those numbers we could see an increase of  550,000 subscribers just from those two countries. This would also explain why Netflix announced that they will increase their monthly subscription fee to produce more original content.

Here is the million dollar question: What will happen to the Netflix stock price?

netflix graph

If they beat their estimates they will sail up to $125 and above, but if they miss they will trail down towards $100 – $96.

I would love for Netflix to miss this quarter so I can scoop up some more before their strong Q4 quarter. However, if they increase their guidance on this earnings report the stock price will already be including that.

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Alexander Wallin is an experienced investor and Fintech expert. He has a passion for startups and making the financial markets more accessible to retail investors. Be sure to follow him on SprinkleBit!

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