Netflix reported first-quarter earnings that beat analyst expectations, but the bigger news is that the company said it plans to raise prices for subscribers and opposes Comcast's impending $45.2 billion merger with Time Warner Cable.
Regulators are in the midst of reviewing the Comcast-Time Warner Cable merger, with an initial hearing held before the Senate Judiciary Committee on April 9 that lacked the presence of representatives from any big media companies that might be opposed to the deal because, in Senator Amy Klobucher's (D-Minn.) words, "many programmers are afraid to go public with concerns about the Comcast-Time Warner Cable deal." Shortly thereafter, Senator Al Franken wrote a letter asking Netflix executives to voice an opinion about the deal, saying the company was "uniquely positioned to gauge the risks."
"If the Comcast and Time Warner Cable merger is approved, the combined company's footprint will pass over 60 percent of U.S. broadband households, after the proposed divestiture, with most of those homes having Comcast as the only option for truly high-speed broadband," Netflix CEO Reed Hastings wrote in his first-quarter letter to shareholders. "Comcast could control high-speed broadband to the majority of American homes ... The combined company would possess even more anti-competitive leverage to charge arbitrary interconnection tolls for access to their customers. For this reason, Netflix opposes this merger."
Hastings added on an earnings Q&A webcast with analysts that if the government ends up approving the merger, it should at least force Comcast to agree to some concessions and that even though its CEO, Brian Roberts, is "incredibly thoughtful," he's not sure that Netflix wants "anyone to control half the U.S. internet."
Hastings' comments are the second blow he has dealt to Comcast after striking a deal under which Netflix would pay the aforementioned "interconnection toll" to ensure more reliable service for its customers streaming movies through Comcast. It was originally assumed that by inking the deal Comcast had made Netflix into a friend, but apparently that is not the case. In a blog post a few weeks after the deal, Hastings argued that big broadband providers should not be able to charge fees for faster and more reliable access.
After Hastings' comments became public, Comcast responded by claiming that it was actually approached by Netflix for the direct ISP connection, at the expense of wholesalers with whom Netflix had traditionally contracted. A statement released Monday by a Comcast corporate communications executive further alleged that Netflix's opposition "is based on inaccurate claims and arguments," and in rather pointed language, stated that if Netflix does not like Comcast's potential merger with Time Warner Cable, Netflix is free to use any other ISP on the market.
"Netflix is free to express its opinions. But they should be factually based," wrote Jennifer Khoury, Senior Vice President, Corporate & Digital Communications, Comcast Corporation. "And Netflix should be transparent that its opinion is not about protecting the consumer or about net neutrality. Rather, it's about improving Netflix's business model by shifting costs that it has always borne to all users of the Internet and not just to Netflix customers.
Taken together, Hastings' blog post and Monday's outright opposition to the deal makes hollow his additional comment in Netflix's shareholder letter that since signing the deal with Comcast, the cable giant "is providing a much improved Netflix experience to their broadband subscriber."
On the back of Netflix's deal with Comcast, AT&T aggressively staked out the position that it, too, should get paid an interconnection fee for carrying Netflix's heavy streaming traffic, which at times accounts for more than one-third of all internet traffic. In a March 21 blog post entitled "Who Should Pay For Netflix," Jim Cicconi, AT&T's senior executive vice president for external and legislative affairs, wrote: "There is no free lunch, and there's also no cost-free delivery of streaming movies. Someone has to pay that cost. Mr. Hastings' arrogant proposition is that everyone else should pay but Netflix. That may be a nice deal if he can get it. But it's not how the Internet, or telecommunication for that matter, has ever worked."
So of course Hastings smacked back at AT&T in his first-quarter letter, saying that the company's fiber-based U-verse internet service performed worse than many of its much smaller, DSL-based competitors.
"The 249 customer comments on AT&T's anti-Netflix blog post indicate that AT&T customers expect a good quality Netflix experience given how much they pay AT&T for their Internet service," Hastings wrote in a clear dig at Cicconi. "It is free and easy for AT&T to interconnect directly with Netflix and quickly improve their customers' experience, should AT&T so desire."
Hastings also wrote, in another surprise announcement, that Netflix plans to raise prices for certain subscribers, a move that may impact future subscriber and revenue growth. Netflix currently charges $7.99 for its streaming service, but the company has been experimenting with different price points, such as the ability to run four streams simultaneously for $11.99. When Netflix last reported earnings in January, Hastings said he hoped to offer three different pricing options for new members, but added that he was in no rush to do so and was still researching options.
On Monday, however, he disclosed that the company concluded "a one or two dollar increase, depending on the country, later this quarter for new members only" is warranted. Existing subscribers will continue to pay their current membership fees "for a generous time period," Hastings wrote. By way of example, after raising prices in Ireland last year, Netflix grandfathered in all existing subscribers to pay their current rate for a period of two years.
"These changes will enable us to acquire more content and deliver an even better streaming experience," he added.
Highlighting competitors ranging from CBS and HBO to Amazon and Yahoo, Ted Sarandos, Netflix's head of content, said of acquiring programming that the "bidding can get quite high for certain talent" and that the company is "committed to larger budget shows." Sarandos said Netflix still plans to double its budget for original programming but to keep it below 10% of its overall content spend.
Netflix released the second season of House of Cards during the quarter and, as usual, did not provide viewership figures, except to say that it "attracted a huge audience that would make any cable or broadcast network happy."
"There was a hunger audience for Season 2 versus a curious audience in Season 1," Sarandos said on the webcast. "There was a lot of pent-up demand, very early, front-weighted viewing for the launch. America was ready for more and dug in right away."
Sarandos' comments are an implied endorsement of the company's strategy of making the entire season of a show available all at once, known in industry parlance as binge-viewing. When BTIG analyst Rich Greenfield pointed out that HBO's True Detective achieved hit status with a week-by-week rollout and asked if Netflix would consider different release schedules in the future, Sarandos said it was possible.
"Our members like to watch more than one at a time, and we're going to stay focused on what our subscribers want," Sarandos said. "Maybe in the future, we roll out shows with different release models."
Netflix shares swing wildly based primarily on the strength of its subscriber addition numbers, which, in turn, speaks to the strength of its marketing, content licensing, and original programming strategy. During the first quarter, the company added 2.25 million subscribers in the U.S., bringing its total to 35.7 million, exactly as it had previously guided analysts to expect. Hastings reiterated again Monday that he thinks Netflix's subscriber base could grow to between 60 million and 90 million in the U.S. alone, which would be two to three times larger than HBO domestically.
Internationally it added 1.75 million new subscribers for a total of 12.7 million. The company is still following an aggressive international expansion plan, and expects to grow overseas subscribers in the second quarter by more than 50% over the same period last year. Netflix now derives 25% of its total streaming revenue internationally and said the overseas opportunity is so large that it eventually expects international revenue to surpass what it generates domestically. It said that its international operation "is on a path to achieve profitability this year," but that the investment required for its expansion plans will keep it running at a net loss.
Combined, Netflix ended the quarter with 48.35 million global subscribers.
The company reported $1.27 billion in the quarter and a net income of $53 million, or 86 cents per share, meeting analyst estimates on revenue and beating on net income. It said it expects to add another 1.46 million streaming subscribers next quarter, with the bulk of them, roughly 940,000, coming from overseas.
After closing the day up $2.75 to $348.49, Netflix shares surged in after-hours trading, gaining $23.01, of 6.6%, to $371.50. That's still below its 2014 high of $454.98 reached on March 4, however.
Update: This post has been updated with comments from Netflix executives on its earnings webcast and additional information from its earnings report.