Global Expansion Drives Netflix; Shares Still Pricey

Netflix NFLX ended 2018 with stronger-than-expected international subscriber growth as the firm continues to benefit from its global expansion. Operating margin came in below our projections, however, as the firm pushed out some of its third quarter content and marketing spend into the fourth quarter. The free cash flow loss for the quarter was a record $1.3 billion, raising the loss for the year to just over $3 billion (19% of total revenue), a figure the firm expects to roughly match in 2019.

We are retaining our narrow moat rating and are raising our fair value estimate to $135 from $120, primarily from incorporating faster international customer growth. We believe the increased U.S. pricing, announced prior to earnings, will be largely offset by lower U.S. net customer additions in the near term and smaller subsequent price increases than the firm would have been able to implement had it taken a lesser increase this year. We also expect that the firm will face stronger competition in the U.S. and internationally, necessitating continuing increases in content and marketing spending which will result in continued cash burn and limited margin expansion over the next three years. In short, we don’t believe Netflix’s current share price considers the potential changes to consumer behavior that a combination of higher prices and increased competition could create, to the detriment of Netflix’s business.

Revenue of $4.2 billion came in line with our estimate. Netflix posted stronger-than-expected subscriber growth in the international segment (7.3 million net adds versus guidance of 6.1 million) but in line growth in the U.S. (1.5 million net adds, versus guidance of 1.5 million). Netflix continues to expand its streaming base, ending the quarter with more than 139 million global paid subscribers, up from 111 million a year ago.

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