Netflix Q1 Earnings: The Silver Lining (NASDAQ: NFLX)

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Sentiment hit an all-time low for Netflix (NASDAQ: NFLX) stock after its 1Q22 report. While disappointing, as I will outline below, I believe that at the current share price level, now is actually not the time to sell the stock. I would like to focus on what management intends to do moving forward and how that could impact Netflix’s share price potential going forward.

Investment thesis

Netflix performed very well as a streaming service company due to the lack of serious competition in its early years. However, the competitive landscape is starting to change as there are several serious competitors who are starting to take more screen time and streaming market share from Netflix. While this new competitive environment may not bode well for Netflix, as evidenced by recent disappointing 1Q22 results which showed slower growth and a loss of subscribers, there are some silver linings in the recent call of the direction we can examine. First, there has been a resetting of expectations regarding Netflix’s future subscriber growth, and additionally, its net additions of 1.1 million users in the Asia-Pacific region. This makes it easier for management to exceed expectations on the subscriber growth front and prepare to continue. monetize password sharing elements. Second, Netflix shared another lever it can leverage for additional revenue growth that management has opened up, which includes a Ad-supported tier plans in the future.

In my opinion, there has been too much negative sentiment in Netflix’s current stock price after 1Q22 results. The company was once a pioneer in the paid streaming service segment and has the ability to produce many decent quality movies and TV series on its own. Although the competition has now become tougher, I think Netflix has the first mover advantage and the best piece of mind as a streaming service, and it will continue to benefit from the tailwinds of the shift from linear TV to streaming services.

Main negative points of the 1Q22 report

The biggest negative headline was the loss of first-time subscribers. The loss of 200,000 subscribers this quarter was a severe blow to Netflix as it suggests Netflix’s growth story may be over. Some of the reasons suggested by management were the impact of the Ukraine-Russia war, churn due to competition from Disney (DIS) Disney+ and Hulu, Amazon’s Prime Video (AMZN) and from YouTube (GOOG) (GOOGL), and finally, due to macro factors like slowdown in economic growth, inflation for example.

Another negative was that management expects margins to be relatively stable in 2023, contrary to initial expectations of a 300 basis point improvement over a few years. This, in my view, reflects management’s cautious view on increasing competition and the need to increase spending to counter growing competition.

Finally, management’s tone towards competitors has changed to become more cautious and negative. The increasing competition was mentioned several times in the call, as management recognizes that it has very good competitors and that Netflix now needs to take it a step higher to be able to compete with them. Of course, it’s a very different landscape for Netflix’s early days when it was the only streaming company with a decent offering. This further worsened sentiment about the margins needed to fuel future growth.

Ongoing content spend while maintaining positive free cash flow

There’s no running away from that. Netflix needed good content to attract and retain subscribers to its platform. The key to getting good content is to keep spending on your original content and building on your expertise in productions.

When asked if the $18 billion in content spending projected for the year would be curtailed or curtailed with the loss of subscribers by the JPMorgan & Chase analyst, Netflix management pointed out that this does not was not the case. I think that’s the right position management is taking, to invest in quality content for the long-term potential of the business. Ultimately, in an environment of increasing competition, I think the need to spend on content and generate quality content is where the differentiation will be in the long run and now is not the time for Netflix to reduce expenses just because of the loss of subscribers for a quarter.

Also, when looking at the 1Q22 content slate, content spend on new content released for the quarter turned in pretty decent results. For example, Bridgerton season 2 surpass season 1 in terms of hours seen.

Even with increased content spend, management continued to commit to being positive free cash flow for 2022 and beyond, which I think is positive for the stock.

Monetization of sharing

With a 100 million households sharing or using another household’s Netflix account as shared by Netflix management, the monetization of sharing capacity offers substantial near-term opportunities.

The initial stance Netflix took on account sharing was that it was good for Netflix because it helped people get interested and started watching Netflix. Netflix launched 2 new paid sharing features to add additional households in 3 Latin American markets. This extra revenue goes straight to the bottom line and is a huge profit machine for Netflix if executed well.

I think now is a good time to execute and act on the monetization of platform sharing between households, because Netflix has already been lenient on sharing for too long and it has achieved the goal of ensuring that consumers start watching and stick to watching Netflix as a habit. Once these consumers become sticky and accustomed to watching Netflix, paying for shared use of the platforms should be relatively easy payoff for Netflix. This huge 100 million households is therefore a significant opportunity for Netflix given that their penetration in several key markets such as the United States and Canada has already reached a fairly high level and to achieve further results, it would be necessary to crack down on account sharing.

Ad-supported plans could provide a much-needed boost

As CEO Reed Hastings underlineit has changed its previous stance of not having ads on Netflix as it now sees a value proposition for a certain group of customers who are willing to have ads as part of a cheaper streaming subscription.

This is how I think Netflix offers an ad-supported plan. With growing competition from Disney (DIS), Apple (AAPL), and Amazon (AMZN), Netflix needs to increase spending on its own productions and original shows, movies, and series to bolster its competitive edge and ensure it continues. to have a reason why subscribers stay subscribed. However, this increase in content spending due to increased demand and the combination of original Netflix productions means that Netflix had to increase the price of Netflix subscriptions. This was the case earlier in the year when Netflix increased the price of subscriptions in the United States and Canada, when the standard package saw its price increase by $13.99 to $15.49. That’s an increase of only $1.50, but it’s an 11% increase in percentage terms. So, for more price-sensitive customers, this price increase was one of the reasons for the loss of 600,000 subscribers in the United States and Canada.

Therefore, it makes sense for Netflix to offer a range of offerings, in addition to its current standard plan, to provide a discounted, ad-supported plan that will capture Netflix’s rather elastic demand. As such, I can see how this new ad-supported plan could add value to Netflix’s current offerings. It could give Netflix the much-needed boost to its earnings, but as Reed Hastings pointed out, it could be more than one 2024 and beyond opportunity.

Evaluation

I applied a 16x EV/EBITDA multiple to my 2023 estimates. For reference, Netflix used to trade in the range of 31x to 52x EV/EBITDA multiple. I think the multiple reflects the relatively slower growth and flatter margin profile in the short to medium term.

This implies a target price of $255 and an implied upside of 14% from current levels. With that, I have a rating on Netflix. I think the current sentiment about the company has become very negative and now is not the time to sell. At the same time, I would need further evidence of improved trading conditions for Netflix to move to a buy rating given the risks involved.

Additionally, Netflix is ​​trading at 17.3x 2023F EPS, which is such a discount from its usual P/E range of 70x to 383x over the past 5 years.

Risks

Subscriber Growth

Risks to subscriber growth could be upside or downside from my estimates or market consensus. With the volatility we’re seeing in subscriber growth, the number could surprise up or down, which has further implications for the investment case.

Impact of price increases

As mentioned earlier, price increases contributed in part to the loss of 600,000 subscribers in the North America region. As such, price increases should be considered as a whole, in terms of impact on subscriber churn and growth.

Macroeconomic environment

As seen in recent results, management cited macro factors as one of the reasons for the weakness seen in recent results. The volatility of the macroeconomic environment in terms of economic growth, inflation, as well as geopolitical risks such as the war between Russia and Ukraine could have an impact and pose additional risks for the company.

Conclusion

As previously highlighted, I believe Netflix’s current stock price weakness is so reflective of negative sentiment that it makes no sense to initiate the company with a sell rating given the prospect of risk reward at current levels. As such, I’ve got a holding rating for Netflix given the multiple silver linings, like monetizing sharing, rolling out low-cost ad-supported plans, continuing to spend on content to build differentiation. With a target price of $255, the upside is currently limited to 14% from current levels.


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