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Netflix Q3 2014 results reveal weak start in Europe

Netflix Q3 2014 subscriber growth

Netflix had a weaker quarter than expected in Q3 adding 3 million subscribers overall. The company attributed the results to stronger reaction to price increases than expected. Judging by after-hours trading, the market is factoring in another new threat to the company: HBO available without a pay TV subscription.

Netflix disappointed both domestically and internationally in the third quarter of 2014. The company gained just under 1M new subscribers in the US, a 2.7% gain over Q2. Last year the gain in the same quarter was 4.3%, and 4.9% in Q3 2012. Q2 and Q3 have been slow quarters for Netflix over the last 2 years. The company attributes this shortfall to the price increases instituted in May of this year, and to the pause in the flow of new original content (to be redressed in the coming quarter.) It should be noted that Q2 and Q3 are usually slow quarters for the pay TV industry too.

I noted last quarter that international markets are now driving growth at Netflix. The company grew subscribers by 2M, or 14.8% over the previous quarter. This is disappointing, though not disastrous, performance in light of the fact that in the previous two third quarters growth was around 19%.

It is too early for us to see the impact of the 6 new European countries on Netflix’ bottom line. However, we can get a hint as to how things might be going in the region by looking at the number of free users of the service. This can be calculated by looking at the difference between total subscribers and those paying for service. If many people in Europe have signed up for a one month free trial there should be an unusual spike in the difference between total and paid subs. In Q2, this difference was about 900,000. At the end of Q3, the difference increased to 1.45 million, suggesting an additional 500,000 potential subscribers are trialing the service in the six new markets.

Is 500,000 a good number? Not particularly. This represents less than 1% of the addressable market in the six new European countries.

This could indicate Netflix will have to work much harder in Europe to market the service. The company has embarked on an aggressive pay-TV operator partnering strategy there in recognition of the special challenges. The Netflix app is already live on set-top boxes from SFR in France and Deutsche Telekom in Germany, and more deployments are expected in the fourth quarter with Orange and Bouygues in France, and Belgacom in Belgium.

Mr. Hastings hinted that it might require patience in Europe. He pointed to the success Netflix has enjoyed in Canada, but cautioned that it had taken 4 years for the market to become profitable.

Though the results are disappointing, the market reaction was extreme. In after-hours trading the share price tumbled 23%, falling 100 points to 339.

It is highly likely the financial markets were also factoring in the news that HBO has decided to do the unthinkable in the US: sell direct to consumers over the Internet. Though details are still sketchy, HBO’s president Richard Plepler said “It is time to remove all barriers to those who want HBO.” This initially caused a small (3%) drop in Netflix stock price, but once the quarter results were announced analyst views turned decidedly pessimistic.

In the short-term, Netflix’ fundamentals look strong and the impact of an OTT HBO won’t be felt until next year. nScreenMedia forecasts the company will finish 2014 with just under 58M subscribers; 37.2M in the US and 15.8M international.

The latest Netflix results can always be found under the Trackers link at nScreenMedia.com.

Why it matters

Netflix turned in disappointing results for Q3 2014, falling short of many analysts estimates and its own targets.

Weakness in the US was attributed to price increases and a lull in the availability of original content.

International markets also came in below expectations. Analysis of the earnings data suggests it will be slow going in the six new European markets.

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