The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.
Netflix (NASDAQ:NFLX) delivered third-quarter results slightly above consensus. Revenue was $1,106 million versus our estimate of $1,102 million and consensus of $1,100 million. The company did not provide revenue guidance. Domestic growth was driven by low churn from Orange Is the New Black, Emmy nominations, and a softer comp. International growth was driven by expansion, as well as a surge in low-quality free trials in September in Latin America. Earnings per share was 52 cents, compared with our estimate of 55 cents, the consensus estimate of 49 cents, and guidance of 30 cents to 56 cents.
Increasing estimates reflecting stronger results and guidance. Our FY:13 estimates for revenue go to $4,363 million from $4,347 million and for EPS to $1.93 from $1.55. Our FY:14 estimates for revenue go to $5,122 million from $5,000 million and for EPS to $3.12 from $1.90 to reflect improving international losses.
We expect original content P&L expenses to catch up to front-loaded cash use. In the past five quarters, Netflix has had negative FCF of $93 million, compared to positive pro-forma net income of $80 million, with a further gap expected in Q4. We believe the discrepancy was generated by “originals” with useful lives of two years, and expect the difference to reverse over the next two fiscal years, placing a drag on EPS of roughly $1.50 per share each year. We think that consensus estimates for Netflix’s EPS potential are overstated.
Several nonrecurring factors positively impacted Q3 subs figures. Q3 featured high-profile Emmy nominations for Netflix originals, spillover from Arrested Development and House of Cards, and the debut of Orange Is the New Black. In addition, the first part of season five of Breaking Bad debuted on Netflix in August, with season three of The Walking Dead available in late September. We believe these shows contributed to low churn in Q3, and expect Netflix to struggle to achieve its Q4 domestic streaming subs net adds guidance of 1.61 to 2.41 million.
Maintaining our UNDERPERFORM rating, but raising our 12-month PT to $160 from $140 to reflect improving domestic streaming profitability and international subs growth. We are grudgingly raising our PT once again as we believe a peer multiple is unwarranted given the potential for slowing domestic growth, coupled with increasing content costs. Our revised PT reflects a sum-of-the-parts that values domestic streaming at $130 per share, up from $112. We are also raising our international valuation to $14 per share from $11.
Michael Pachter is an analyst at Wedbush Securities.