Thread by @JerryCap

1) $NFLX Q2 2019 missed subscribers estimates by the largest magnitude in its history (domestic subscribers: -126K versus +300K guidance; international subscribers: +2.8 million versus +5.0 million guidance).

https://twitter.com/JerryCap/status/1118616508790341632

2) This large miss is somewhat offset by:

A) the companies Q3/19 guidance above consensus (+7.0 million versus +6.4 million consensus; domestic guidance +800K versus consensus +900K and international +6.2 million versus consensus +5.5 million).

3)

B) the company believes they will hit their full year 2019 subscriber targets (implicit Q4 guidance raise)

“Our internal forecast still currently calls for annual global paid net adds to be up year over year.”

C) beats on most of the $ stuff

4) This is exactly what you would expect a quarter digesting a price increase to look like, so why wasn’t $NFLX able to see that in their forecasts, and if they could not see this large Q2 miss, why should we trust them for their guidance for 2H 2019?

5) Well historically they have been too optimistic in Q2. The red dots are the misses (three of the last four came from Q2, in 2016, 2018 and now 2019).

6) As their subscriber base grows the absolute magnitude of their misses increases (need to look at percentages). We can see that while this was their largest miss in absolute values it was also their largest miss (defined as positive and negative variation) in percentage terms.

7) But they are particularly bad at (and high) with their Q2 guidance when compared to Q1 guidance (of course now that this is known it is useless information)

8) It is important to note that $NFLX isn’t giving guidance in the typical way that Wall Street gives guidance, conservatively so they can beat and raise, but rather discloses what they call their “internal forecast”.

9) Looking at the absolute variation in their internal forecasts, it is pretty volatile quarter-to-quarter (in both directions) but has proven to smooth out over the course of the year. This type of “guidance” is consistent with many owner/operator led companies.

10) $NFLX Guidance: “the quarterly guidance we provide is our internal forecast at the time we report. We strive for accuracy (not conservatism). In some quarters we will be high and other quarters low relative to our guidance. In Q2’19, our membership growth forecast was high.”

11) The short answer to why should we trust 2H 2019 guidance well using all my intellectual power and bull market reasoning it is because in the past their YEARLY sub additions have been pretty good forecasts, and I believe they will continue that way. I could be wrong.

12) Is it possible Q2/19 marks the inflection point in $NFLX stock, right ahead of some competition, sure, but is it probable? I do not believe so.

13) The narrative at the time of the price increase was subs adds must be so good in Q1 that they feel comfortable raising prices ahead of the onslaught on new competition (plus the anticipation of some content losses, The Office + Friends + many others over the next 5 years)

14) Well we got 9.6 million paying subscribers in Q1 2019 which seemed to confirm this thesis, case closed...

15) While that might be true there is another theory that might make sense in that this price increase was actually more of a defensive move rather than an offensive move.

16) In order to see this we need to define the $NFLX “flywheel”: spend money on content -> drive new subscriber additions/lower maintain churn -> increase prices -> spend more money on higher quality content -> drive new subscriber additions and lower/maintain churn

17) Importantly the “increase” prices part of the flywheel is an upfront hit (see investment) to the current subscriber base with a lagged benefit (the price increase doesn’t translate into new content on day one).

18) Make no mistake the $NFLX library will be deeper and richer because of this price increase and by the time the company fully realizes and passes off the benefits of this year’s pricing cycle it will be when there ACTUALLY is new competition.

19) In short, if I was running the business I would push through a price increase BEFORE the competition came into the market for a lot of psychological/strategic reasons.

20) Better to have people forget about the price increase 12 months from Q1 2018 and churn around now, recapture them with a strong 2H 2019 in conjunction with the increase focus from competitors, i.e. Q3 DIS+ launch)...

21) ... rather than wait out and push through the price increase when there are new entrants in 2020 and beyond.

22) Sometimes when planning on holding a stock where almost all the value (in terms of FCF generation) is far out into the future we have to look at short-term blips as unavoidable volatility towards the terminal value of our initial thesis.

23) … There is nothing “yet” that shows this has been invalidated.

24) But there is situation that could be teeing up which could give way to a layup opportunity in $NFLX over the next 12-to-18 months so if you want to own the most dominate company in the media business at a reasonable price, start doing your work now we might see it.

25) How?

If 2H misses and we get the releases of Disney+ AppleTV+, HBO MAX, etc, the market will start to extrapolate some pretty bad outcomes for $NFLX, but they are all within the realm of “normal noise” within the path to a global subscriber base of hundreds of millions.