Netflix Inc (NFLX) — Q4 2020 Earnings Call Transcript

Thank you, Spencer, and good afternoon, everyone. So maybe, Spence, we could start off with you. Just given the guidance and the beat during the quarter relative to guidance, sequentially the first quarter tends to be higher in net additions than Q4. But your guidance is lower, despite the fact that you beat Q4 by a relatively large amount, and it feels like the pull forward effect is more or less behind us. So if you could just help us walk through the thought behind the guidance and the framework that you use for that, that would be a good place to start.

Yes, sure, Kannan. Well, great to see you. Happy New Year, obviously delayed. So in terms of the guide, first of all, we guided to 6 million paid net adds for Q1 if you saw. And obviously, that's still a big number, especially when you think about it in context of 2020, which was by far a record year with 37 million paid net adds. So I know you mentioned the pull forward, I don't think we're declaring that we're necessarily through that yet. So, there's puts in calls every quarter, but one that's still a meaningful factor for us in the guide is thinking through how we kind of grow through that growth from 2020. So there's probably still a little bit of that pull forward during a hammock period in early parts of 2021. And then more broadly, Kannan, it's just so difficult in this time. This is one of the more uniquely challenging times, not just for life, but that's most important, but also obviously in terms of trying to just forecast the growth trajectory of the business. There's just so much uncertainty right now. So it's more uncertain than we've ever seen. And we're trying to forecast through that. But at the same time, one thing that's maybe counterbalancing that is that what COVID has done for us is it's accelerated that big shift from linear to streaming entertainment. So the long-term growth trajectory is at least as strong as ever. There's just more short-term noise and uncertainty right now, but still very strong underlying growth metrics and that's what you're seeing in the Q1 guide.

Okay. And I guess if you just look at the full year in terms of cadence, '21 obviously has tough comps versus 2020. But I think one of the things you guys also indicated was potentially a 4 million to 5 million pull forward into 2020 from a growth perspective. And I think there's been a lot of debate about what you actually meant by that 4 million to 5 million. So, if you can just contextualize the guidance for Q1 more in the context of 2021, you typically do 28 million to 30 million subs in a given year. Is that framework more or less intact or should we read that 4 million to 5 million comment as a pull forward into '20?

Well, look, I'll take this one. Others can jump in as well. Unfortunately, Kannan, we're not going to provide a full year guide. Just as we talked about, there's so much uncertainty in the business. We can provide a number, but I'm not sure it would be worth, it would be that bankable, right. It's hard enough to project the next 90 days, let alone the next 12 months. But we feel very good about, as I said, is that longer term growth trajectory, you've seen us as you pointed out historical growth trends. Hopefully, it would be plus or minus that. But it's a bit impossible to predict. What we do see is that viewing is up in every region of the world. It's kind of returned from those peak COVID levels, but it's up year-over-year in all regions. Retention is better than it was a year ago. Acquisition is strong. So the underlying metrics are strong in the business, but I don't want to provide false precision on a 12-month target.

Got it. And if you could touch on a couple of regions. The one thing that stood out during the quarter, of course, is UCAN where most of us thought the market was saturated, but you guys keep accelerating growth, despite price increases, which is even more impressive. And then the other region, which until Q3 seems to be, despite the benefit of COVID seemed to have slower growth than 2019, despite the market not being saturated. So if you could just talk about the underlying trends in some of these markets and what you're seeing, which is driving some of these trends, that might be useful.

You want me to go or someone else want to go? Okay. I'll go again, Kannan. I think the story is pretty similar throughout the world. Every country is a little bit different. But what we're seeing in terms of our viewing trends are similar around the world, the types of content that our members are viewing is kind of similar to pre-COVID and post-COVID. Obviously, we have more and more variety of content and great experiences that we're offering to our members. But the story is pretty similar. As you know, there are certain countries around the world where we’re just further along in our content market fit and our maturation, but we're seeing growth everywhere. Like you pick Latin America as an example, one of our more mature markets, you look over the past few years and we've been steadily growing about 5 million to 6 million paid net adds a year. As you mentioned, in kind of US UCAN market, we're roughly 60% penetrated and we're still growing. So we're still a very small share of even just pay TV penetration in most markets around the world and small share of viewing. So we think we've got a lot of headroom in all these markets, and we’re just trying to get a little better every day.

Kannan, if you take the U.S. being our most penetrated market, we're still under 10% of television viewing times Netflix. So again, there we've got a lot of subscribers here in the U.S. But we still have a lot more viewing time that we would like to earn with an incredible service and incredible content.

And Spence, maybe one last financial question before we move on to the more interesting part of the discussion.

I take offense to that last comment, Kannan.

But the one thing obviously which is new in the letter this quarter is the cash flow guidance and your cash flow guidance is better than what you guys initially indicated and the buyback guidance. So maybe you could talk about capital allocation and using the cash for buybacks versus potentially other opportunities. And also why use an absolute gross debt number instead of a leverage target to frame the buyback discussion? So it would be helpful to get that context.

Yes, sure. Thanks. We're super proud of where we are from a free cash flow perspective and we talked a bit internally before the calls, what was a bigger milestone for us? Passed 200 million member mark or kind of turning to this next chapter in terms of our free cash flow and the ability to self-fund our growth going forward. And we think that's a pretty big milestone for us. To the point of our capital allocation approach, the philosophy remains unchanged, which is that we're going to be disciplined stewards of the capital and try to do things that we believe are value maximizing for our shareholders. But we have turned this corner where now we can, as we talked about, with $8 billion of cash on the balance sheet, projecting to be cash flow about breakeven in 2021 and then positive thereafter, we want to return excess cash to our shareholders. So, we won't build up a bunch of excess cash. We'll maintain, as you say about – as we said in the letter, as you mentioned, about $10 billion to $15 billion of gross debt on the balance sheet. And that's really just to maintain familiarity and access to the debt markets should we need it, but there's really not a whole lot of science beyond that. And then beyond that, as we say, we put a premium on balance sheet flexibility, so we're going to continue to invest aggressively into the growth opportunities that we see. And that's always going to come first. But beyond that, if we have excess cash, we'll return it to shareholders through a share buyback program.

Okay. And Reed and Ted, if we could just pivot to a question on competition. This question may feel a little bit unfair to be honest, because in many ways you created the streaming template for others to replicate. But given Disney's recent success and the kind of numbers they are putting up, it almost feels like Netflix is underachieving versus its potential and has to work a lot harder to get to comparable scale. So are there any reasons why the Disney numbers are not a benchmark for Netflix and why the company can’t get there?

I'm sorry I had to frame it that way. In the bottom of our earnings, the return to annualized return over 18 years is 40%. If that's underperformance, we'll gladly take more of that. It's super impressive what Disney has accomplished. Their execution in shifting from an established player to facing new competition is remarkable. It shows that members are interested and willing to pay for more content because they crave great stories, and Disney offers some fantastic narratives. This excites us about expanding our membership and increasing our content budget. It's great for the industry to have Disney and Netflix competing, show by show and movie by movie. We're particularly energized about potentially catching up to them in family animation, and maybe even surpassing them in the future. There’s still a long way to go just to catch up, while we work on maintaining our lead in general entertainment, which is incredibly thrilling, especially with shows like Bridgerton that I don’t think you’ll see on Disney anytime soon.

No, I think when discussing competition, we can refer to Christmas Day 2020 when highly anticipated films like Wonder Woman '84 and Soul debuted on competing services while we launched what became one of our most successful offerings. I believe, as Reed mentioned, this highlights the significant demand for high-quality entertainment across various forms. The willingness of consumers to pay more for additional programming is very encouraging. Our goal has always been to create everyone's favorite show and film. Other companies will also pursue this aim, and many individuals will complement their Netflix subscription with that content, which fosters a healthy competitive environment.

But if I could just add as well, I think there's the membership lens and the number of subscribers, but it's also useful to look at it from a revenue lens, which of course is the fuel that we have to basically create more of that content to get that virtuous cycle flowing more.

So you took the bait. Can I just try to get us the chest pound some more?

It was intended to be thought-provoking, but a follow-up is warranted, and Greg, I believe you have a lot to contribute on this topic. When considering the entry of Disney or Discovery and the various new launches occurring, this essentially broadens the streaming landscape significantly. Additionally, new distribution models are emerging. Telecom companies are beginning to view this as the new norm, and I anticipate this will result in numerous adaptations moving forward. So, as we foresee more streaming services being introduced throughout 2021, does this create an opportunity to explore new distribution methods or to accelerate growth due to the rising demand for streaming?

I think you're right. We're seeing this big macro shift and certainly the global pandemic has accelerated that process. And really I think the first bit is just even that big impetus to move is to some degree a tailwind for us, because we have more and more consumers who are around the world, who are aware of these services. We have more and more intention, more activity out there. We are seeking to be innovative and constantly pushing the edges around how we can accelerate our growth, how we can improve our distribution footprint, how do we access members more and more? And also, and what's really the key engine of our growth is just how do we satisfy those folks that have signed up for us, because that really is the ultimate stimulus when they have a great experience and they talk wildly about how great the service is, how amazing the titles that they're viewing there to their friends, their family, their colleagues, that's really what motivates that next round of subscribers to sign up. So we'll keep pushing the edges. We seek to be innovative in that way. And we'll come up with many creative ideas as we can to grow.

All right. And I guess extending on that topic, you ran a couple of interesting experiments during the quarter. I think Netflix was free in India for a weekend and in France you have tried the linear format. So could you talk a little bit about the learnings from these experiments? And are these successful enough to expand to other regions?

Yes. So StreamFest in India, the primary learning which was very evident is that there's a lot of interest amongst consumers in India to try Netflix. We had millions of people that had access for a 48-hour period to the service. And now we go through the more difficult part of actually analyzing how that interest through this specific tactic translates into sustained incremental growth. And we're still working through the details of that. And obviously based on what we see there we’ll inform how we think about how we leverage that tactic again, or how do we improve on it, what other places we think it might be leverageable. And then on to your other point, I think Netflix members come to the service seeking to be entertained in a whole variety of ways. Sometimes they're looking for a movie or sometimes a TV show or animation or scripted or unscripted, and sometimes they show up and they're not really sure what they want to watch. And so we've had the opportunity to try and be innovative and try new mechanisms to sort of help our members in that particular state. So there's the linear feed isn't one example of that, it's still unclear how that's going to work out. So we're still looking at that one. But I think an even better example of that is a new feature that we've been testing and we're going to now roll out globally, because it's really working for us where our members can basically indicate to us that they just want to skip browsing entirely, click one button and we'll pick a title for them just to instantly play. And that's a great mechanism that's worked quite well for members in that situation.

Greg, are we going to call it, I'm feeling lucky or are you going to come up with something better?

We're going to come up with something better than that, so stand by for this. You'll see it when it rolls out.

And so, Greg, just following up on Asia a little bit more, you mentioned the $4 billion to $5 billion in revenues that Netflix has been able to add over the last few years. As India becomes a bigger region and as your reliance on growth in that region increases, is that $4 billion to $5 billion the right way to think about revenue growth? And also, because of the ARPU of course in that region being much lower, how should we think about that framework for revenue growth going forward?

Yes. We're proud of the consistent annual revenue growth between 4 billion and 5 billion, which we believe is unmatched in the entertainment industry. Our goal is to continue this growth. Specifically, we need to improve the accessibility of the Netflix service, which often requires making trade-offs between subscriber growth at different average selling prices. Our approach to these decisions and how we expand and evaluate our strategies is fundamentally centered on revenue optimization. This perspective will guide us as we strive to maximize revenue growth.

And I’ll just add to that, Kannan, just in this past quarter, the APAC region was the second largest contributor to growth and you see the kind of revenue acceleration frankly that's happening in our business from about $4 billion increase over the total year, two years ago to about 5 billion this year just in our guidance for Q1, it's 24% year-over-year, so on an absolute basis, that revenue is growing.

When you think about the APAC region, obviously that region is very different in terms of price sensitivity and the kind of diversity the region has languages and so on and so forth. So when you approach that particular region, is the present model more or less the steady state of trying a mobile-only kind of a plan and then trying to upgrade people from there or are there other things you can do either in terms of pricing or product to potentially accelerate that?

There are 100 things that we can and we need to go do and we know that it's really not about just one trick or one thing that will basically make us successful in the region, but it's just constantly looking at all of the ways in which the current product experience doesn't satisfy completely our members or members to be. And you mentioned language, it's a great one where even simple things like we're improving the ability for our members to tell us what languages they want in terms of the content when they're browsing, and there's sort of these different scenarios. There's a scenario maybe when you're by yourself and if you're multilingual, that can result in sort of different choices. If you're in a multi-generational household, then all of a sudden that might shift how you think about, like what titles you want to present and what languages and so that's just one small example of places where we know we can improve the product experience and be more effective in satisfying members. But it goes on and on from that to like the methods of payments that what we know we need to expand and we're constantly working to add more of those and make those more effective, the partnerships we have that make the service more accessible and more immediate and easier for members to find out and sign up. So there's tons of things that we're looking at.

Okay. And speaking of an area of overachievement instead of underachievement, Ted, 70 movies in a year. So now you guys are the industry in many ways. I think the top five studios potentially do about 90 movies a year. You guys are doing 70 a year. So at what point is this too much? How do you judge that balance? And how are you juggling, or how are you evaluating returns on this investment?

It's likely more than 70. That's what we discussed in the last release and the exciting trailer. When considering how diverse people's tastes are and their appetite for movies, it's clear that it's not just one a week. There's significant potential for growth, and we are already scaling up considerably. With movie stars like Gal Gadot, Leonardo DiCaprio, and Meryl Streep, along with filmmakers like Jane Campion, Adam McKay, Zack Snyder, and Antoine Fuqua creating films for Netflix, people can enjoy movies at home, on the big screen, or on their phones. I believe this evolution will continue to expand well beyond one movie a week, as we aim to cater to a global audience with incredibly diverse preferences. There are weeks where we release two or three films, many of which have a notable impact in their respective regions. Some of these films even become global hits, like #Alive from Korea last year, which was a significant success for us worldwide.

And when you make these titles, you innovated with respect to the kind of financial model on content creation with a cost plus kind of a structure relative to the deficit finance models in the past for content. When you do the kind of output that you're doing and the volumes that you're doing, is there a risk that this leads to lower returns over time, because there is really no downside in some ways for studios to create this content on a cost plus basis? And does it make sense at this scale versus when you were essentially doing originals as a startup?

I think it does. We're seeing it scale up more than double every year and it continuing to scale both in the scope of the projects, the ambition of the projects and the execution of the projects. And I do think the financial return, if you think about it relative on a handful of titles that wind up doing enormous return for the studio versus the hundreds of titles that barely break even, this is a great model for producers to produce in. And the fact that we can support it day-in and day-out at this kind of volume and make projects that are otherwise pretty difficult to make in some cases has been really encouraging for filmmakers just to embrace this model.

And given the kind of volumes that you're doing on movies now and also because of COVID, there's been a significant shift in the release patterns for movies, not just at Netflix, but across the industry, does this in some ways create essentially a new distribution channel for you? If the length of releases or shorter windows become more acceptable, does it become possible for you to essentially tap the box office with wider releases on a very short window? And does that become a new revenue stream at some point?

Kannan, potentially. We've looked at this before. We've never had any issue with movies being in theaters. Our biggest issue has been that you had to commit to this very long window of exclusivity to get access to any theaters. That's been the biggest challenge. So if those windows are going to collapse and we'd have easier access to films, to show our films in theaters, I'd love to have consumers be able to make the choice between seeing it out or seeing it at home, which is becoming the norm during COVID certainly, and we'll see how much that sticks. But I think that consumer behavior, human behavior, things changed a lot over time. But there's a very different experience associated with going out and going to the theater with strangers and seeing a movie and it's fantastic. It's just not core to our business.

Hopefully, with Warner Brothers sort of COVID move, what we'll see is post COVID, like the second half of the year, is that people both go to the theaters in significant numbers and watch their films. And they're premiered simultaneously on HBO Max and then that will really set a path for simultaneous, was good for the film, helps both online and on streaming, and then also in the theaters. But we have to wait to post COVID to get a clean read of that.

Yes. So what you're seeing today though is exactly what we've been trying to do for a couple of years since making these films at this size.

I guess the other side of this coin is given your distribution scale now, if a studio wanted to release a movie on Netflix, this is one of the most efficient channels they can get to. Why is that not an attractive model for Netflix, either in the form of a premium VOD channel or some other distribution model? But why is that not an attractive model for you?

We're not saying that it isn't. What we're saying is that this model has been the most appealing for both consumers and our business.

Kannan, I think you alluded maybe to a different model, sort of a transactional kind of approach. And I would say that we really believe that from a consumer orientation, the simplicity of our ad-free, no additional payments, one subscription is really, really powerful and really, really satisfying to consumers around the world. And so we want to keep emphasizing that.

That's an interesting challenge for people to understand the benefits of subscription models, as they allow consumers to explore a wider range of content. This means many preconceived ideas about what is popular or not can be set aside, since those ideas are often based on business trends rather than consumer preferences. For instance, someone who usually doesn't watch foreign language TV might hear about a show like Lupin and become excited to watch it, and since it's included in their subscription, they give it a try. Ten minutes in, they may find that they actually enjoy foreign language television. This change reflects a remarkable evolution. Bong Joon-ho captured it perfectly at the Oscars when he mentioned that audiences need to overcome the one-inch barrier to access an entirely different realm of entertainment. We're already witnessing this broad acceptance by providing great stories from across the globe to audiences everywhere on Netflix, with that one-inch barrier being the subtitles, dubs, or the original language track.

And I guess when you have this kind of content volume and also the kind of movie slate that you're putting up, it also gives you a lot more pricing power because instead of watching a movie for $10 or as a family for $30, you essentially pay for Netflix. So your pricing power implicitly goes up in this environment because of the kind of product.

We are enhancing the value proposition for consumers. Each additional 10 minutes of viewing on Netflix adds value to your subscription. By expanding the options available, we increase the likelihood that you will start watching, and once you do, we believe you will enjoy what you find.

Kannan, when it comes to out of home entertainment, most consumers perceive that differently. Just like cooking at home can be inexpensive, people still choose to dine out because it offers a different experience. Our members don't see that as a direct alternative. However, what they appreciate is being able to watch an unlimited number of shows at an affordable price, allowing them to experiment with their viewing choices, such as trying Alice in Borderland or Lupin. All of these elements are connected to create a truly unique and exceptional viewing experience.

When considering these factors, there are two perspectives on pricing in the current environment. One perspective recognizes that high competition means consumer spending is spread out more widely, suggesting limited pricing power. Conversely, there's also the possibility that your share of total engagement continues to rise and the overall market could grow. This could lead to increased product offerings, with consumer spending shifting from other areas like television. Which of these dynamics should we anticipate? In other words, will pricing power accelerate or will ARPU growth accelerate in the upcoming years, particularly in Western markets?

Yes. I would say our competition set we think of is extremely broad, whether you think about it as share of wallet or share of time and attention, share of entertainment, share of delight, and we feel like we have so much more room to grow. And really it's exciting to now see the sort of new dimensions of value creation for our users, like bringing foreign language show; Lupin, Casa de Papel, shows that are now becoming global hits from countries and in languages that that's never happened before. So that's super exciting to see that kind of value creation. And that's really just where we stay focused. So we're not trying to predict the future in that way, but just stay tightly, tightly disciplined on trying to think about what's that next incremental step where we can create more value for our members, engage them, delight them, more great content, more great product experiences. And if we think we do that well, then we think our business will grow and turn.

Kannan, we've been quite careful and will keep being careful. Spencer Wang, can you remind us of the average revenue per member over the last three years? What has it increased from?

Yes, it's about 10% over three years, so pretty cautious and it's working well for us to provide incredible value.

Yes, maybe just another way of stating that cautious is just thinking about it. We do think we're an incredible entertainment value. We want to remain incredible in entertainment value.

I’d like to remind you of the releases we had on Christmas Day, where we showcased various titles. Just before that, we released Midnight Sky, and shortly after, we launched Cobra Kai. A few days later, we introduced Lupin, followed by Pieces of a Woman. The reception has been phenomenal, and the viewer numbers clearly show how much people are enjoying these series and films. This level of engagement has been unparalleled, and I believe it perfectly illustrates what consumer value means.

And just the recent data points, Kannan, we referenced in the letter, but we had price increases in the U.S. in the fourth quarter. We announced in the UK in December and we've grown nicely through that, because I think to this point we're continuing to increase the variety and value of what we're delivering for our members.

And I guess on the pricing front, at a certain level, there's some academic research on this. But essentially, elasticity seems to be a function of the price itself, which means as you go higher and higher when you start taking price up, potentially maybe the elasticity of demand changes. But is that something that you guys have seen yet or are we still very far away from that point at which these factors kick in for you? So if you could just talk about what you've seen so far as you've taken price up across different regions in terms of potentially churn or cohort behavior, that might be a useful framework for us?

Yes. And I think rather than sort of that academic perspective, we look at it perhaps more practically and more operationally and really it's almost reversing it, which is that we are looking for signals and signs from our members that are telling us essentially that we have added more value. So you think about engagement with the service and retention and churn characteristics, acquisition, those are the things that we're really looking for that are key to basically saying, okay, we've added more value in the service. Now it's the right time to go back to those members and ask them to pay a little bit more so that we can reinvest it and keep adding it. So it's really that sort of iterative feel our way forward kind of orientation that we have.

Got it. Pivoting to a slightly different topic, you guys added Strive Masiyiwa, I hope I'm pronouncing that right, to the Board. And Africa is not a region we've discussed in the past, but Disney started creating a lot of content in the region. And obviously, this Board appointment is pretty interesting. Is this the next focus? How should we think about this as an opportunity?

Strive is a global board member. He is not joining us as a marketing consultant for Africa, even though he has extensive knowledge of the region. Instead, he brings expertise in building large subscription businesses, an area in which he has significant experience. His sophisticated approach to dealing with governments is increasingly vital as we grow. He serves as a valuable global advocate for us and has a strong understanding of Europe and reasonably good knowledge of other regions as well. This addition to our global board membership is part of our ongoing efforts to expand in that area. Africa holds immense potential, and we are creating more content there and growing our membership. However, Strive's specific role does not focus on Africa alone.

And just looking at the rest of the world, there's been a lot of small transactions, and Spencer this one might be for you and I'm sure the others will chime in as well. But there have been a couple of streaming services in Southeast Asia, which essentially were acquired by some of the Chinese internet majors. Sony, of course, did the acquisition of Crunchyroll. So there's been interesting assets, which could have helped you scale potentially faster, but obviously you guys passed on it or did not really show any interest in these assets. So could you help us think through what kind of assets you guys would care about as it's more like world assets or why are these assets not interesting?

I’d just add that historically, we've been builders, not buyers. And years ago, I used to try to get the team to wrap their head around the potential scale of the business by saying things like, someday we'll be so big, we'll have a VP of anime. And then that someday is now. We're one of the largest producers of anime in the world. So you think about those kinds of things now and it's like what were you when you look at those assets, they're primarily distribution assets, not really IP assets. So that's – and where we've been taking the approach like with our unscripted programming, with our anime, with our animated features, with big budget original film, we're building over a couple of years versus acquiring.

Spencer, I have one final question regarding the long-term outlook for the business. Ted, feel free to add your thoughts as well. Do you have any regrets about opportunities you missed? For instance, if Roku had remained part of the company rather than being spun out. Additionally, when you consider the competitive landscape, what do you see as the real competition? Is it primarily streaming services, or do competitors like Fortnite, which you've mentioned before as a driving force for consumer engagement, play a role?

I’m going to see how he does on this one.

Materially, I think it is fantastic that we've executed if we had kept Roku inside, it's very unlikely they would have been the success that they have. What Anthony and his team have done has taken enormous energy and focus on their side. And it was an enormous task for us just to become a leader in both streaming and then original programming and then global. So we’re happy for their success, but no regrets on that front.

Got it.

I would think with the hours and hours of joy we're bringing to hundreds of millions of people around the world and with their return to our shareholders, it's hard to look back with much regret.

Here’s one for you, Kannan. We regret not buying a global license to House of Cards in the first year, because we had to go back and piecemeal that extraordinary expense.

That's a good note to end on I guess.

Thank you, Kannan, and thank you to all of our shareholders and look forward to talking to you in another quarter.

Thanks, guys.

Happy New Year.