'Underlying Characteristics' of Netflix Business 'Intact' Despite Subs Shortfall, Says CFO

Though Q2 subscriber growth outside the U.S. was up 8 percent year over year, it “wasn’t up as much as we thought it was going to be,” and the shortfall was “pretty broad across multiple markets,” not just “one area of the world,” said Wells. The company’s target was for Q2 international subscriber growth to exceed 20 percent. In the U.S., Netflix had 670,000 net subscriber adds, 44 percent below Q2 projections.

In quarterly subscriber growth, Netflix “clearly didn’t have the number,” but the company is convinced the “underlying characteristics of the business haven’t changed,” said Wells. “Our total addressable market is intact,” as is the “conversion and growth to internet-enabled entertainment,” he said. “People are loving it. People are adopting Netflix around the world, increasingly more in our newer markets as well.” Wells thinks Netflix is “still on track for a strong growth year this year and maybe it's going to come in a little bit differently than we expected and others expected.”

The company took a pounding from analysts Tuesday for the subscriber miss and lackluster Q3 forecast showing net subscriber adds are expected to decline 6 percent from the same quarter a year earlier. One analyst questioned whether Netflix had hit a “speed bump or a brick wall.” Another said the “bubble” had burst on the stock, which closed Monday a shade higher than $400, minutes before the company released results. Shares opened 13.2 percent lower Tuesday at $347.74, and closed the day down 5.2 percent at $379.48.

Netflix faces a tough financial squeeze in future quarters between having to pay increasingly higher procurement costs for original content and enduring downward pricing pressure as the company moves to build subscription bases in poorer economies, said MoffettNathanson. "Looking out over time, we would expect the next set of markets to require lower initial pricing and more localized content in order to drive penetration higher."

That Netflix is taking on “a lot of new and strengthening competition” is a phenomenon that’s “all normal and expected,” said CEO Reed Hastings. He cited Disney’s entry into the direct-to-consumer streaming market and HBO “getting additional funding” through completion of AT&T/Time Warner. The competitive landscape “is what it is, we're not going to be able to change it,” said Hastings. “Our focus is on doing the best content we've ever done, having the best user interface, the best recommendations, the best marketing, all of the things that we've been doing for many years in the past and we'll keep doing for many years in the future.”

The market for internet entertainment “is so big that there can be multiple firms that are successful,” said Chief Content Officer Ted Sarandos. “You've heard us talk in the past about how we've been able to grow dramatically in the U.S.,” while HBO and other networks “have also similarly been able to grow at the same time, so it's a very large market,” he said.

In such a competitive environment, the reliance that Netflix places on licensed content from Disney and Fox has been “on the decline for several years,” said Sarandos. “The way we looked at this long term,” Netflix knew “that our competitors will want that content on their own services,” he said. “That was a bet we made a long time ago” when Netflix decided to go into original programming, he said. “Every year since that, we've been doing less and less off net business with Disney and Fox.” In the “short to medium term, we're still licensing content off net from them and they're also producing original content for us,” he said.

Though Netflix is “excited and optimistic” about the prospects of building subscriber acquisitions through its “partner bundles” with Comcast and others, “the vast majority of our acquisitions still comes by consumers signing up directly with us,” said Hastings. Netflix is still “fairly new” to the partner bundles, and thinks those will “grow as a percentage of our acquisition,” he said. “What we’re really excited about is that actually allows us to sort of more efficiently address different consumer segments.”

In marketing the Netflix app through partner bundles in well-penetrated markets like the U.S., “doing a deal like with Comcast allows us to put the application on the set-top box,” and appeal to consumers who aren’t “early adopters” and are used to watching “traditional television,” said Hastings. “By being included in a bundle, we get to remove a separate purchase decision” for those consumers, he said. “We get to eliminate the sign-up flow, which just makes it super-simple and easy for consumers to sign up via that mechanism.”