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Netflix (Buy, $154 PO) Stock view: Easy comps ahead with more content on the way Heading into 1Q earnings, we expect Netflix to beat subscriber estimates given strong recent content launches, and accelerating subscriber growth in Europe. Key 1Q titles included A Series of Unfortunate Events, 13 Reasons Why, and Marvel’s /ron Fist. We see few competitive issues this quarter to impact subscriber growth and we think the release of Marvel’s lron Fist likely helped quarter ending subscribers, despite low metacritic scores. Fans of the Defender series still seem to be watching the show with Parrot Analytics indicating viewership was just below Luke Cage its first week (though viewership dropped by half within the first 10 days). In addition, fan ratings came in at 81% on Rotten Tomatoes despite the poor critic reception. For 2Q, we expect a solid guide as Netflix laps 2Q16’s price increases internationally and in the U.S. This should help churn rates for 2Q especially in Europe where we think the bulk of Netflix subscriber growth will originate for 2017. In addition, Netflix has a stronger slate of titles vs. 1Q including key franchises like House of Cards, Orange is the New Black, Sense&, and other new series. Although competition is increasing in the SVOD space with Amazon, Hulu and other making original content, we still see Netflix as ahead of the competition due to: 1) sheer volume of content production with over 1000 hours in 2016, with strong local market content that can be leveraged globally, 2) competitive price points vs competitors; and 3} the largest volume of 4K content which attracts new TV purchases. 4K TVs could drive upside to estimates in FY17 as Netflix is one of the few services with a library of 4K content. For 1Q contribution margins, we estimate that Netflix will reach a new high at 41.3% U.S. contribution margins somewhat offset by international contribution margins which we expect to close to zero at 1.5%, but still a large improvement over 4Q’s 8% loss. We expect Netflix to run its International division at new break even margins through FY17 and begin to gradually lift international margins in 2018. As Netflix reaches Intl profitability, the investor story may focus more on EPS growth in the coming years. Key theme/metric(s) for 1Q: Net sub adds internationally and 2Q guide For 1Q we see two critical metrics that we think the Street will focus on; 1) Net Intl. subscriber additions as Netflix laps the launch in 130 countries globally; and 2} 2Q net subscriber guide for Netflix in the U.S. Although 1Q domestic subscriber ads are important, we think the Street would be willing to look past a lower domestic number on stronger international growth. In 2Q Netflix could potentially hit a flat subscriber growth quarter as 2Q is typically seasonally weak, though we note the content slate for 2Q16 has several top franchises with new seasons. Chart 11: Domestic subscribers Chart 12: International subscribers 60,000 8% 70,000 90% 50,000 Oe aN . 7 , 4% 70% 40,000 2% 50,000 a 60% 30,000 O% “a > hie 8% 30,000 40% i. Oy 0, cone io 20,000 ome ‘O ‘0 10,000 2% 10,000 10% 0 0% 0 0% © © © © .© .© © © & & & H& WOW LC LL LC L FHKE IPH SS s ss mmm U.S. Subs (000's)\ == Y/Y Growth mame International Subs (000's) === Y/Y Growth Source: BofA Merrill Lynch Global Research estimates, company report Source: BofA Merrill Lynch Global Research estimates, company repor 28 Internet/e-Commerce | 06 April 2017 Bankof America 2 Merrill Lynch HOUSE_OVERSIGHT_014914