hocus-focus
Following yesterday’s earnings announcement, Netflix, Inc. (NASDAQ:NFLX) shares have been soaring today by 15%. In my last article about the company, I had argued that subscriber loss is anticipated up to a certain degree, when new kids enter the block and that the ad-tier would boost revenues and subscribers. Under this prism, let’s see some of my thoughts on yesterday’s earnings.
Whining easement No. 1: No more subscriber loss
I remember an old TV advertisement of Snickers, which had the following slogan: “You’re not you when you’re hungry. Eat a Snickers.” Listening to the market complaining about the falling number of Netflix subscribers, that’s what came to my mind. I mean, as I said in the introduction, you can expect a new entry to cut their margins in order to attract new subscribers, and that’s what is being done. In Netflix’s earnings call, I read this:
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.
And still, despite this statement, the company managed to add almost 2.5 million net new subscribers and reach a total of 223 million subscribers globally. The situation had become intolerable, and hopefully this quarter will put an end to it.
Whining easement No. 2: Ad – tiered plans will enhance revenues and bring in new subscribers
Netflix showed an overall 6% revenue growth, on a YoY basis, including the forex effect. Excluding forex effect, the revenue growth reached 13% on a YoY basis. Taking a closer look, we can see that the largest revenue increase was found in Latin America, where revenues increased by 9%, including forex effects. If we exclude the forex effect, revenues in Latin America increased by 16%. On the contrary, the largest decline in real revenue growth was found in the Asia – Pacific region.
The above picture raises an issue. It appears that the company did well in terms of revenue growth, excluding the effect of foreign currency. However, it would be crucial to answer the question of how the current dollar exchange rate will affect the company’s revenues in the future. While this is not a macro outlook article, a few points are necessary in the effort of judging this earnings report. I will try to make this concept easy to grasp.
Let’s imagine a Netflix-like platform and create two points in time. Point A, and point B, which is 12 months later than point A. In point A, 10 U.S. dollars can be exchanged for 8.5 Euros, while in point B, exchange rates have changed in a way that 10 USD is now equivalent to 10.20 Euros. However, customers based outside the U.S. pay their subscriptions in their local currency. That is, Eurozone – based subscribers have agreed to pay Netflix 8.5 Euros per month, which was the equivalent of 10 USD in point A, when they originally subscribed to the platform. However, if the subscription price policy doesn’t change, the platform ends up getting less than 8.5 USD in point B, as dollar has strengthened substantially. So while everything goes according to plan, the real results are mediocre.
So, is this going to continue forever? No, because the FED’s actions could be considered hostile, especially by their European counterparts. Also, inflation won’t last forever. Neither will the war in Ukraine, although the U.S. will continue to sell LNG for many years to come, but that’s another issue. But until this changes, exchange rates aren’t an ally of Netflix.
This is where the ad-tier becomes a gamechanger. It’ll give the company the opportunity to increase its earnings (dollar-wise) without increasing their prices further. Or at least without increasing their subscription prices much. The ad-tiered plans will become reality in November across many countries, which account for 75% of the global on-demand show market share. It is estimated that the ad-tiered plan will bring in about $2 billion in revenue, in the next five years.
A word of caution
As with everything on this planet, the key is to be moderate. In my previous article, I had written that in the ad-tiered plan, advertisements wouldn’t exceed four minutes per hour. Now we learn that the ad time will be around 5 minutes per hour, which is 25% more. In a Netflix series scenario, each episode typically lasts around 50 minutes. Assuming two 45 second ads in the beginning of each episode and two at the end, this leaves us with two minutes of remaining ad time to be filled while watching the show. I would strongly prefer one more minute. The moral of the story is that the ad-tiered plan could easily be transformed from a blessing to a curse, should Netflix decide to stretch it out with more ads.
Bottom line
I continue to be long in Netflix. As I’m writing this article, the share price has pulled back from the 200-day moving average, but since the major whining issue seems to have gone away, I don’t see why anyone wouldn’t like the company. After all, with high inflation, people tend to cut their outside spending, and spend more time home. Thus, for home entertainment businesses, this is good news.
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