Netflix blames tax dispute in Brazil for rare quarterly earnings letdown

Key Points

• Netflix missed its earnings target due to an unexpected $619 million expense related to a tax dispute in Brazil, breaking a six-quarter profit streak above analyst projections.
• Despite the earnings miss, Netflix reported a revenue growth of 17%, matching analyst forecasts at $11.5 billion.
• Netflix shifted its focus from subscriber growth to financial performance, evidenced by a 40% rise in stock price this year, although shares fell about 5% in extended trading following the earnings report.
• The company is diversifying its content portfolio by integrating more live sports, video games, and plans to expand into video podcasts, while also eyeing potential acquisitions from Warner Bros. Discovery.

Netflix missed the earnings target set by stock market analysts during the video streamer’s latest quarter, a letdown that the company blamed on a tax dispute in Brazil.

The results announced Tuesday broke Netflix's six-quarter streak of posting a profit that eclipsed analysts' projections.

The Los Gatos, California, cited an unexpected $619 million expense tied to the Brazilian tax dispute for the earnings shortfall while hailing its lineup of distinctive TV series and films for keeping its audience engaged and delivering a mix of subscriber fees and increased ad sales that helped it deliver revenue that matched analyst forecasts.

Investors, though, weren't placated by the explanation as Netflix's shares still fell by about 6% in extended trading after the numbers came out.

Analysts varied in their interpretation of the third-quarter report.

Investing.com analyst Thomas Monteiro worries Netflix is using the Brazilian tax hit as a way to mask signs of a slowdown in subscriber growth and advertising amid economy uncertainty. “The truth is that the company failed to deliver the kind of growth we’ve grown used to over the past couple of years,” he said.

But Zacks analyst Jeremy Mullin said he sees little reason for concern, asserting Netflix's “underlying story remains solid.”

Netflix earned $2.5 billion, or $5.87 per share, in its July-September quarter, an 8% increase from the same time last year. Revenue climbed 17% from last year to $11.5 billion. Analysts surveyed by FactSet Research had predicted the Los Gatos, California, company to earn $6.96 per share on revenue of $11.5 billion.

Delivering solid financial growth has become more important than ever for Netflix as management has steered investors from fixating on how many subscribers its service gains from one quarter to the next. As part of that process, Netflix stopped disclosing its subscribers at the end of last year.

The shift has paid off so far, with Netflix’s stock price rising about 40% so far this year, although the downturn in extended trading signaled some of those gains are about to evaporate.

Although Netflix no longer reveals the specific, this year’s revenue growth signals that its worldwide subscriber count has increased from the roughly 302 million it had at the end of last year – by far the most among video streamers, even as rivals with deeper pockets such as Amazon and Apple expand their programming selections.

In the company's quarterly conference call, Netflix co-CEO Ted Sarandos said the streaming service's total worldwide audience — including multiple people living in the same subscriber household — is approaching 1 billion.

“We have a better understanding of the streaming business than any of our competitors,” Greg Peters, Netflix's other co-CEO, boasted during the call.

Netflix has maintained its lead by adding more live sports and video games to supplement its wide array of scripted programming – a diversification effort that will expand into video podcasts from Spotify next year.

And now Netflix may have another opportunity to add even more compelling programming with Warner Bros. Discovery announcing it may sell all or part of its holdings, which include HBO, DC Studios and CNN. Analysts are already speculating that Netflix may join the bidders looking to grab a piece of Warner Bros. Discovery.

In response to a question about Netflix's acquisition strategy, Sarandos noted that the company traditionally has been “more builders than buyers” without ruling out a potential bid for some of Warner Bros. Discovery's properties other than cable TV networks like CNN and TBS. “We can be and will be choosey,” Sarandos said.

The company has also mining a new vein of revenue by selling commercials as part of a low-priced option of its service it introduced three years ago.

Although the advertising business still isn’t large enough to require the company to disclose its sales, management expects its revenue to more than double from last year. A recent analyst by S & P forecast $1.1 billion in ad sales for Netflix this year — a figure that would represent about 2% of its projected total revenue.

It’s getting to the point that Netflix may be in danger of trying to juggle too many ball at once, said Forrester Research analyst Mike Proulx. “If the company goes too broad to become all things entertainment, it risks diluting its core.”