Is Netflix In The Catbird Seat Now? Some Analysts Are Convinced

As Netflix itself acknowledged, it had a “bumpy” start to 2022, including subscriber losses and a plummeting stock price. But following a strong fourth-quarter performance report on Thursday, Netflix’s price, which was still down by about 40% year-over-year after rallying in the second half, rose more than 6% in aftermarket trading.

The company’s Q4 revenue rose 2% year-over-year, to $7.85 billion, slightly exceeding average analyst estimates, driven by a 4% increase in average revenue per member (ARM). Paid subscription adds of 7.7 million in the quarter dramatically exceeded Netflix’s own projection of 4.5 million, driving its world-leading total to 230.75 million — up from 223.9 million sequentially and from 221.84 million year-over-year.

Earnings per share of 12 cents didn't even approach the average estimate of 44 cents, and were down from $1.33 in Q4 2021, which Netflix attributed to non-cash unrealized losses from foreign exchange (FX) headwinds.

But Netflix remains the only profitable major streaming service, and it is projecting that it will nearly double its already impressive $1.6 billion in free cash flow in 2022 to $3 billion in 2023. The company said it expects to achieve double-digit revenue growth and an expanding operating margin next year, driven in large part by its recently launched ad-supported tier, Basic with Ads, combined with a crackdown on subscription password sharing and full-throttle implementation of paid sharing starting this quarter.

Netflix — which reportedly refunded some Basic with Ads advertisers after missing viewership guarantees due to lack of inventory — shared precious few specifics on the performance of the two-month-old plan.

Instead, executives reiterated that Netflix launched the tier in just six months’ time, that they are “very pleased” with its performance so far, and that the advertising offering’s evolution will be “crawl, walk, run.” They also said that much has been learned already, and that while much remains to be done, improvements — including targeting and ad format enhancements, better ad delivery validation, and expansion of its measurement partnership with Nielsen and the addition of Kantar — are already underway or in the offing.

However, a few nuggets were proffered.

For instance, while the ad-supported tier's tech is working, and “the product experience is good,” work is needed on some “nuts and bolts,” like better coordination between the Netflix and Microsoft ad sales and operations teams, acknowledged COO and Chief Product Officer Greg Peters — who, it was revealed, is now being promoted to co-CEO, with Ted Sarandos, as founder Reed Hastings shifts from co-CEO to executive chairman.

More intriguingly, Peters reported that the ad-supported plan’s users’ engagement is “comparable” to that of subscribers to its no-ads plans, and “better than [Netflix] modeled’; that the consumer uptake rate and subscriber growth for the with-ads plan is “solid” (“within the middle of our other plans”), in part because of incremental adds driven by its lower price point; and that the amount of switching from the higher-priced no-ads plans to the lower-priced Basic with Ads plan is “less than expected.” (Good news, since the costlier plans help drive ARM.) All in all, the unit economics of the ad-supported plan as modeled “remain very good,” he said.

CFO Spence Neumann elaborated a bit, saying Netflix believes its advertising business can eventually surpass Hulu’s, based on its unit economics and larger scale potential.

“I want to emphasize that it’s a multi-year path,” he said. “So we’re not going to be larger than Hulu in year one. But hopefully, over the next several years, we can be at least as large… We were at nearly $32 billion in revenue in 2022, and we wouldn’t be getting into a business like this if we didn’t believe it could be bigger than at least 10% of our revenue and hopefully much more over time in that mix, as we grow.”

Analysts’ reaction to the earnings report was largely positive to enthusiastic, with several predicting that, for all of its turmoil during 2022, Netflix will emerge as a bigger winner than ever in the years ahead.

LightShed Partners' Rich Greenfield summed up the enthusiast viewpoint.

Noting that Netflix’s decision to stop providing guidance on subscriptions growth reflects the reality that growth in revenue and profits is what matters to investors now, Greenfield told CNBC that advertising represents “huge opportunities” for Netflix. The company’s guidance of 8% organic revenue growth for Q1 2023 is “very conservative,” he said. “I think it will move into the upper teens, if not 20%, as the year goes on.”

“Many analysts said that Netflix would never make money, that streaming is a bad business,” but Netflix is spending $17 billion a year on content and will generate at least $3 billion in free cashflow this year — “up 100% year-over-year and off to the races in the next few years,” Greenfield adds. “Tremendous free cashflow was something no one was expecting from Netflix.”

Meanwhile, “so many media companies are rushing to try to get to profitability, and don’t know how to do it, so they’re cutting costs, cutting marketing, cutting content spend,” he points out.

There hasn’t been enough focus on the fact that the media companies that own the other big services are now scaling back on investment in streaming, which will give Netflix even greater advantage in 2023 and 2024, he argues. While Netflix has said it will continue its current level of investment in content — which allows it to create an industry-dominating amount of quality programming — the competitive pullback means that Netflix will be able to spend less, on a relative basis, on marketing and some other items, which will also help drive free cashflow, he says.

“They are managing this model very well, relative to everyone else,” concurred media executive Tom Rogers, executive chairman of Engine Gaming & Media and a former CEO of TIVO and president of NBC Cable. “They have a model down now that none of the others, including Disney, has,” he told CNBC.

Rogers cites the size of Netflix’s content budget, its much lower churn than competitors, and its ability to maintain higher engagement levels amid intense competition. Netflix’s engagement in terms of time spent went from about four times that of Disney+ to about six times during Q4, he said. (Also see LightShed’s summary of Q4 Nielsen stats on major streamers’ programming engagement, top of page.)

Netflix “attracts all demographics" — including beating Disney at attracting younger audiences — and its average revenue per subscriber “just continues to grow,” Rogers says. “Look at Asia, where Disney now has average net revenue per sub of about 50 cents. Netflix is coming in at about 20 times that in the Asian market.”

Separately, Livy Investment Research noted that while Netflix saw a slight decrease in overall ARM due to “extreme” FX challenges in Q4, it “outperformed expectations in terms of sales, with robust subscription gains in all operating markets and ARM growth in core regions.”

In Q3 2022, Netflix revealed that its average monthly revenue per subscriber in North America was $16.37.

Despite slowed growth in U.S. and Canada, Netflix’s approximately 74 million subscribers roughly match the number of cable/satellite subscribers in the U.S., and Netflix will grow by adding the large number of households that will be established by younger consumers in the years ahead, Rogers believes.

“People aren’t going to have cable and satellite; they’re going to be streaming… [and Netflix is] going to be in the pole position and be in every streaming home,” he predicts. “In short, there’s nothing that dissuades me from the view that [Netflix will be] the winner among all media companies, by far.”

Of course, even with the positives in Q4, not everyone is as bullish on Netflix.

Several analysts pointed out that successful execution of ramping up the critical new ad revenue stream and implementing paid sharing are not guaranteed.

“Looming macro headwinds and the wider rollout of paid sharing beginning 1Q23 will likely weigh on Netflix's normalizing profits further, making the stock vulnerable to the anticipated continuation of broader-market volatility,” wrote Livy’s analysts.

Netflix acknowledged that its subscriber growth will be impacted for a time by churn caused by implementing paid sharing, but said it would soon regain momentum.

“We believe we have a clear path to reaccelerate our revenue growth: continuing to improve all aspects of Netflix, launching paid sharing and building our ads offering, Sarandos and Neumann wrote in the company's Q4 shareholder letter. “As always, our north stars remain pleasing our members and building even greater profitability over time.”

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