Wachiwit
Background
As part of my preview of Netflix, Inc.’s (NASDAQ:NFLX) Q4 financials, I considered the likelihood that the Q4 results would beat the consensus expectations. I recommend that you familiarize yourself with my previous article before reading this one.
Netflix’s Q4 actual results exceeded my expectations, management’s forecast, and consensus forecast, so investors were pleasantly surprised. In a previous article, I expected management to provide a weak Q1 subscriber forecast. However, I did not take into account the fact that management will not provide a subscriber forecast for the next quarter starting from this reporting.
Nevertheless, the 1Q revenue and profitability forecast cannot be called positive. The key issue in the company’s investment case is the current valuation of the company’s shares, which are traded significantly higher than other companies from the FAANG+ group and competitors in the media sector. At the same time, I cannot explain NFLX’s high valuation by better attractive fundamentals of the company in comparison to peers, as its fundamentals are worse. As a result, I maintain my negative view on NFLX’s stock, especially as the company enters a seasonally weak quarter. However, I note the company’s initiatives to solve problems with account sharing and launch an ad-supported plan as good long-term business growth drivers.
Revenue
Excluding the impact of the U.S. dollar strengthening, Netflix revenue growth was 10% YoY. Recall that about 55% of the company’s revenue comes from regions outside the U.S. and Canada. The company surprised investors with a net addition of 7.7 million subscribers, beating the consensus estimate of 4.5 million. However, this result was the weakest since 4Q2017. Revenue per subscriber was $11.5 (-2% YoY, -3% QoQ), adjusted for F/X impact, revenue per subscriber grew by +5% YoY. Although the actual results are very positive, I have doubts that the company will repeat the success in Q1 2023.
Margin
Netflix operating income was at $550 million (-13% YoY, margin of 7%), while the consensus-forecast was at $372 (margin 5%). The result was better than expected due to higher-than-expected revenue and a slower-than-expected rate of new hiring. Free cash flow (“FCF”) was at $332 million (4% margin). Consensus forecast FCF at (-$266) million. EPS was at $0.12 (-91% YoY, 70% worse than consensus). The main factor that had a negative impact on EPS was the revaluation of the euro-denominated bond ($462 million unrealized loss or $1.02 negative impact on EPS).
Geographical breakdown
In the regional context, the largest net subscriber addition was in the Europe, Middle East and Africa region (EMEA), where 3.2 million subscribers were added during the quarter. Revenue in this region decreased 7% YoY to $2.3 billion (1% better than expected). Excluding the impact of the U.S. dollar strengthening, growth was 5% YoY. Revenue growth in the US and Canada was 9% YoY, and the number of subscribers increased by 0.9 million. In Latin America, the net subscriber addition was at 1.8 million, and revenue growth was at 5% rate YoY (excluding F/X impact the revenue growth rate was 7%). Revenue from the Asia-Pacific region decreased by 2% YoY, despite the growth of subscribers in the region by 17% YoY. Excluding the impact of the U.S. dollar strengthening, the revenue decline was 4% YoY.
The performance of the ASAP region raises concerns, as this region has been a major contributor to subscriber growth in previous quarters. The fall in the APAC revenue, even adjusted for the strengthening of the U.S. dollar, is especially worrisome. I assume that this is due to the growth of subscribers in countries with lower subscription cost and, as a result, with lower ARPU. In contrast, subscriber growth in the Latin America region was 4% above consensus expectations. It looks positive given the launch of an initiative in the region to address the account-sharing issue.
1Q2023 outlook
Netflix management’s guidance for 1Q is $8.2 billion in revenue, implying 4% YoY growth. Excluding F/X impact, the revenue growth is expected at 8%. From this quarter, management no longer plans to provide a forecast for subscribers for the next quarter. I missed this fact in the preview of NFLX’s 4Q financials. However, management noted that they expect moderate subscriber growth in 1Q. 2023 operating profit is expected at $1.6 billion (20% operating margin). Last year, the figure was at the level of 25%.
Management explains the possible decrease in margins by the timing of content costs. Diluted EPS is forecast by management at $2.8. Management’s revenue guidance was in line with consensus expectations, while operating income was 5% worse than expected and diluted EPS was 6% worse than consensus expected. As before, I suggest that 1Q2023 results may be worse than consensus and management’s expectations due to the poor content release schedule.
Other key issues
Earlier, I noted that Netflix management’s comments on three main issues are important for the investment case of a company:
1) Launch an advertising plan
2) Solving the problem of account sharing
3) Development of the video game segment.
The launch of the ad-supported plan took place in November 2022. Management noted that they are satisfied with the first results. It was also noted that the engagement of subscribers on this plan is similar to the engagement of subscribers on the standard plan, and switching from the standard plan to the ad-supported plan is low. However, management also noted that the positive impact of ad-supported plan on NFLX’s fundamentals will be moderate in 2023, as it will take time to roll out this plan. Given the weak state of the global advertising market due to problems in the world economy, I do not expect a significant contribution of ad-supported plan to the company’s revenue in the next six months. Nevertheless, in the long term, this initiative is certainly positive.
In the first quarter, Netflix, Inc. plans to roll out the paid account-sharing program it piloted in Latin America more broadly. Management expects that, at the initial stages, some households may cancel the subscription, as they need to pay extra for additional devices. Solving the problem of subscription sharing is important for the company, as about 100 million households share NFLX’s accounts.
Regarding the development of the video game direction, no additional significant comments were received from the management. About 50 mobile games have already been released under the company’s franchises. However, these games are more of an opportunity to test the interests of subscribers. In Q4, the company closed the acquisition of a small video game developer, Spry Fox.
Final Thoughts
Netflix, Inc.’s factual net subscriber addition turned out to be significantly better than I and the consensus forecast expected. That can be explained by a tight release schedule in Q4 2022 and the launching of an ad-supported plan.
However, given the poor release schedule in the first quarter and the company’s high valuation relative to its peers, I maintain my short-term negative view on NFLX’s share. I opened a short position at $335. I note that my negative view is short-term. In the long-term period, I like the investment prospects of Netflix. However, the first half of the 2023 year is not likely to be positive for the company’s business, especially given the state of the global economy.
It is likely that, as in the past year, Netflix, Inc. shares will become more interesting to buy closer to the middle of the year. I also note Reed Hastings’s exit from the CEO position may add uncertainty to the growth prospects of Netflix, Inc.’s business in the nearest future.
Be the first to comment