Netflix co-founder and CEO Reed Hastings on the red carpet for the Netflix launch at Palazzo Del Ghiaccio on October 22, 2015 in Milan, Italy.
Jacopo Raoul | Getty Images
Netflix’s Q2 earnings results can be interpreted in two very different ways. The future of the company depends on which reading turns out to be correct.
On Tuesday, the world’s largest streaming company announced that it had lost almost 1 million subscribers in the three-month period from April to June, marking the second consecutive quarter of losing customers. Still, that’s less than the company’s forecast loss of $2 million, with Netflix stock up about 6% to $214 at noon Wednesday.
The second quarter results offer Netflix investors a new bullish argument. If the quarter serves as a “bottom” — the point at which Netflix stopped losing subscribers and started growing again, even if at a snail’s pace — investors have a new growth story. Netflix predicts that the number of subscribers will increase by 1 million in the next quarter. This may be the main reason for the rise in shares on Wednesday.
“As there are signs of a stabilization in the subscriber base, we believe the prospect of an extended period of subscriber loss is becoming increasingly unlikely,” Stifel analyst Scott DeWitt said in a note to clients. On Wednesday, Stifel upgraded Netflix stock to Buy.
But the results, which some investors considered good enough, may bring only temporary relief. The bearish argument for Netflix is that Wednesday’s stock price jump is a “dead cat bounce” – Wall Street jargon for a temporary recovery after a significant drop. Netflix is facing increasing competition from major players moving into the streaming market, including Disney+ Disney+, Peacock NBCUniversal and HBO Max. This has raised questions about whether Netflix can maintain its dominance, especially in the lucrative US market.
New business to grow
Previously, Netflix bulls leaned toward the idea that the company would turn its massive global reach of 221 million subscribers into positive free cash flow by raising prices and reducing churn. This transformation from a loss-making enterprise to a free cash flow machine would enrich the shareholders.
It has already happened, or at least should happen. Netflix said in its shareholder letter that it will have $1 billion in free cash flow by 2022. In 2023, Netflix stated that free cash flow would “grow significantly”.
Yet Netflix shares are still trading 70% below the all-time high set in November.
The second wave of subscriber growth could be the company’s new narrative for investors. There is reason to believe that Netflix subscribers will pull ahead again. Netflix has announced that in 2023 it will stop distributing passwords and launch a cheaper tier of ad support. Both of these initiatives could lead to an increase in the number of registrations.
End of your heyday
Unless Netflix’s subscriber growth accelerates, the second quarter of 2022 will be a watershed moment when it becomes clear that the company’s blissful days are over.
“Where does its sub-loss end, given strong competition from newer, lower-priced, richer streaming services?” writes Needham analyst Laura Martin. “222 million subscribers worldwide could be peak subscribers for Netflix.”
This could be the case if Netflix can’t turn enough of its password users into long-term paying subscribers. Netflix said in its shareholder a letter that he is encouraged by his early findings from tests in Latin America that he can turn those who share passwords into paying customers.
In a conference call on Tuesday, Netflix CFO Spencer Neumann said the company plans to spend about $17 billion on content in 2022 and will remain in that “zip code” for the next “several years.” This is a change from almost every year in the past decade that Netflix has ramped up content spending to increase its market share. As revenue growth has slowed, Neumann acknowledged that spending on new programs will also be modest.
“Our content spending will continue to rise, but it will be more moderate as we adjust our revenue growth,” Neumann said.
It remains to be seen if Netflix can continue to grow its subscriber base without an ever-increasing content budget, especially since the company routinely raises prices every year. The concern is particularly acute in the US and Canada, where Netflix lost 1.3 million subscribers in the second quarter, marking the third quarter in five years in which its customer base has dwindled.
“Given the risk of increased churn with each price increase from now on, the real concern is that it will be difficult for the company to significantly accelerate growth in these regions,” said Michael Nathanson, an analyst at research firm MoffettNathanson.
In the coming years, investors can look back to the second quarter of this year as the moment Netflix either began its second run or began its slow migration into value stocks.
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