The streaming giant added more customers than expected, but free cash flow burn continues to accelerate.
By Neil Macker, CFA | 07-17-17 | 10:25 PM | Email Article

 Netflix posted a very strong second quarter in terms of subscribers as the firm blew away its prior guidance. Despite the large beat on subscribers, both revenue and segment contribution came in only slightly above our projections.

Neil Macker, CFA, is an equity analyst for Morningstar.

However, the firm continues to burn cash at a faster pace with a free cash flow loss of over $1 billion in the first half of 2017 versus a loss of over $500 million in the first half of 2016. Despite the beat on subscribers, our long-term thesis for the stock remains in place. Thus, we are retaining our narrow moat rating and our fair value estimate.

Netflix reported much better-than-expected paid subscriber growth in both international (3.73 million net adds versus guidance of 3.20 million) and U.S. segments (0.95 million net adds, versus guidance of 0.60 million). Since management has attributed net add outperformance to excitement around original content, the outperformance in the second quarter should have been expected given the large slate of originals released in the quarter. The company also issued better-than-expected subscriber guidance for the third quarter. Netflix continues to expand its streaming base, ending the quarter with more than 99.04 million global paid subscribers, up from 78.80 million a year ago.

U.S. paid subscribers grew at a faster pace than we previously projected as trailing 12-month paid net adds were 4.3 million in the quarter, down 13% from 4.9 million at the end of second quarter of 2016 which was down 17% versus 2015. We are currently modeling an 18% average annual decline in total U.S. net adds from 2018 to 2021 with an 8% decrease in 2017, but our projections (and consensus) may prove to be optimistic. Netflix will need to continue to ramp up its investment in original content at the expense of acquired content, possibly increasing pressure on margins and free cash flow.

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Neil Macker, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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