Investors hope Netflix can recover as subscriber numbers start to grow again.
 

Netflix subscribers hit new record

Netflix (NFLX) added 2.4 million net paid subscribers in the third quarter of 2022 to end the period with a record 223.1 million of them using its service. That impressed considering it was only aiming to add 1.0 million of them, and it also means it has recouped all the 1.2 million subscribers it lost during the first half of the year.

The company said a strong slate of content helped attract users, having launched the latest series of the popular Stranger Things series, a new film named The Gray Man starring Ryan Gosling and Monster: The Jeffrey Dahmer Story.

Netflix beats expectations

Netflix revealed that revenue rose 5.9% to $7.9 billion in the third quarter and operating income – its headline measure – fell 13% to $1.5 billion as its margin has been squeezed by rising costs this year. These results smashed expectations considering Wall Street had forecast more tepid 4.5% topline growth and a sharper 28% drop in profits.

Both the top and bottom lines were hit by the strong US dollar considering Netflix makes over 60% of its revenue outside the US and this will knock-off around $1.0 billion off sales and $800 million off operating profit over the full year.

The company said it is still aiming to deliver $1.0 billion in free cashflow over the full year following a significant improvement in the latest quarter, which was welcome considering Wall Street believed this target would be lowered. It said its operating margin will still be 19% to 20% this year at constant currency but admitted this will be lower when unfavourable exchange rates are taken into account.

‘Over the medium term, we believe we can adjust our pricing and cost structure for a stronger US dollar world. Our long term goal remains unchanged - to sustain double digit revenue growth, increase operating profit even faster (as we expand margins) and deliver growing positive free cash flow,’ Netflix said.

Netflix reclaims streaming crown from Disney

Netflix briefly lost its title as the largest streaming service when it shed subscribers for the first time in over a decade in the first half, with Disney taking the lead as its three services – Disney+, ESPN+ and Hulu – all continue to grow at a much faster pace. Netflix has reclaimed its crown following the beat in the third quarter:

(Source: Company Reports.Please note Netflix follows the calendar year while Disney’s financial year runs until early October, so Disney’s figures trail that of Netflix by around one month)
 

However, Netflix is likely to lose it once again when Disney reports its next set of quarterly results on November 8, and it could be for a longer period this time unless it can revive growth considering markets believe Disney will add 11.6 million subscribers across its three services in the three months to early October to end the period with 232.7 million.

Netflix said it is aiming to add 4.5 million subscribers in the fourth quarter of 2022, which was also more optimistic compared to the 4.1 million additions pencilled-in by analysts. That means Netflix is aiming to end this year with 227.6 million while Disney is expected to end January 2023 with 246.1 million, according to consensus numbers from Bloomberg.

However, Netflix warned it will no longer provide guidance for paid subscriber additions going forward as revenue is now its primary topline metric as it diversifies its income by moving into new areas such as advertising. It will still report subscriber numbers each quarter.

Is Netflix the king of streaming?

The company sent a message yesterday that, while it needs to rejuvenate subscriber growth and is feeling the pressure from more intense competition, it is still the king of streaming.

Netflix is the most watched streaming service and claims to have ‘higher engagement than any other streamer’. Below is an outline of the share of video viewing time in the UK and share of TV time in the US. Netflix says this data demonstrates it still has ‘plenty of room to grow’:

(Source: UK data from BARB, US data from Nielsen)
 

Plus, while rivals may be growing their subscriber numbers at a faster pace, Netflix stressed they are losing significant sums while it remains profitable, and therefore more sustainable.

‘Our competitors are investing heavily to drive subscribers and engagement, but building a large, successful streaming business is hard - we estimate they are all losing money, with combined 2022 operating losses well over $10 billion, vs Netflix's $5 to $6 billion annual operating profit,’ Netflix said.

‘Ultimately though, we believe some of our competitors will seek to build sustainable, profitable businesses in streaming - either on their own or through continued industry consolidation. While it’s early days, we’re starting to see this increased profit focus - with some raising prices for their streaming services, some reigning in content spending, and some retrenching around traditional operating models which may dilute their direct-to-consumer offering. Amidst this formidable, diverse set of competitors, we believe our focus as a pure-play streaming business is an advantage,’ the company added.

We know that Disney’s Direct-to-Consumer division that homes its streaming services reported operating loss of $2.5 billion during the nine months to July 2 and that is expected to rise to $3.5 billion by the end of this financial year. Amazon does not breakout its figures for Prime Video, although it is likely to be losing considerable sums. It is important to remember that video streaming is just one of several features of a Prime subscription. Unlike Netflix, they both have huge operations, from Disney’s theme parks and merchandise to Amazon’s ecommerce platform and cloud computing arm, that are helping generate the vast sums needed to subsidise their costly streaming ambitions.

Netflix to launch ad-supported service

The main weapon being wielded by Netflix in its fight to revive subscriber growth is a new cheaper tier that will be supported by advertising. Netflix had originally planned to launch this in 2023 but recently revealed this will be launched next month at a price that is around 20% to 40% cheaper than its current cheapest ad-free tier. Viewers can expect to see around five minutes of ads for each hour of content, although up to 10% of Netflix’s programmes will be unavailable due to licensing restrictions.

It is important to flag that Netflix is not expecting any material contribution from the new ad-supported tier, named Basic with Ads, in the fourth quarter of 2022, making this a new catalyst that will steal the spotlight in 2023.

Netflix is initially launching the service in 12 countries which, it says, spend over $140 billion on advertising across TV and streaming services each year, representing about 75% of the global total.

‘The reaction from advertisers so far has been extremely positive and we believe that more choice, especially for more price conscious consumers, will translate into meaningful incremental revenue and operating profit over time. That said, it’s still very early days and, since we’re keeping our existing plans ad-free, it will take us time to build up our membership base and the associated ad revenue,’ Netflix said.

Netflix did not outline any firm targets for the new ad-supported tier, although chief operating officer did nod earlier this month toward a recent Wall Street Journal report that said it wanted to have 13.3 million ad-supported subscribers on its books in the US by the third quarter of 2023. That same report said Netflix is aiming to have 40 million users on its ad-supported tier globally by the same deadline (although this will be a different metric to include entire households rather than individuals). UBS said the new service could boost Netflix’s revenue by 10% over the coming years, while Atlantic Equities has estimated it could add $6.7 billion in revenue within the first three years of launch. For context, Netflix reported just under $30 billion in revenue in 2021.

The cheaper tier should hold some appeal. Netflix believes there is over 100 million households skirting its subscription fee and is now trying to offer them cheaper accounts in the hope of converting them into paying subscribers. Netflix said it plans to start addressing the problems spawning from password sharing in early 2023 by allowing ‘borrowers’ to transfer their existing profiles – along with all the recommendations and personalisation that come with it – into their own account.

‘In countries with our lower-priced ad-supported plan, we expect the profile transfer option for borrowers to be especially popular,’ Netflix predicted.

Where next for NFLX stock?

Netflix shares are trading 12% higher in pre-market trade today at $269.10 – marking a new six-month high - after the results allowed the stock to break above the ceiling that has held it back in recent months.

The question now is whether the breakout can lead to a sustainable rally. Notably, trading volumes have seen notable daily increases over the past three sessions and yesterday came in 2.4x the 100-day average, while the RSI is now close to entering bullish territory.

The next upside target is the 200-day moving average at $283, in-line with the level of support seen in late 2019. From here, it can target the pandemic-induced lows of $295 seen back in March 2020 before a larger jump toward $323 can come into the crosshairs.

On the downside, the $250 ceiling that had proven a tough ceiling to break should now emerge as a new level of support going forward. Any slip back below here risks seeing the stock fall back toward the 100-day moving average.