Streaming giant Netflix Inc (NASDAQ: NFLX) reported a better-than-expected financial performance during its latest third-quarter earnings.
The increase in its subscriber numbers suggests that the worst is behind the company.
Total revenue was up 6% year-on-year to US$7.92 billion, beating consensus estimates of US$7.85 billion.
Adjusted earnings before interest, tax, depreciation and amortization (EBITDA) also beat expectations by US$1.77 billion, to US$1.46 billion.
The strong earnings reflect the additional 2.41 million subscribers, bringing its total to 223 million subscribers globally.
This has helped the rebound in its share price throughout this week.
Introduction of AVOD-tier could bring in more subscribers
During the earnings call, a lot of the discussions were focused on Netflix’s ad-supported tier.
The launch in November means that investors will have a glimpse of the impact in fourth-quarter numbers.
However, there is concern among investors that the new tier could cannibalise its existing subscriber base.
Management, however, appeared confident that the ad-tier will mostly be net new subscribers rather than a shift towards a cheaper plan by existing subscribers.
Netflix’s COO Greg Peters, said:
“Yes. It may be relevant to note that we don’t see a lot of members switching plans. So oftentimes when they come in and they select the plan for a given feature, let’s say, that’s the 4K resolution.
We see that to be a pretty sticky choice. And so, when we’re thinking about unit economics being neutral to positive, we’re really comparing to the like feature set in the basic without ads.”
I believe there is still room for Netflix to build up its offerings over the next few quarters to attract more advertisers onboard.
It is also too early to call it a success given the intense competition in the ad-supported streaming content space.
Among some of the examples include Amazon Freevee, Pluto TV, Tubi and the Roku channel.
Competition remains intense
Netflix continues to build up its content pipeline, which makes it one of the favourites in the streaming space.
While the recent increase in subscribers is a relief for some investors, the competition in the space remains intense as HBO Max, Amazon Prime and Disney+ all want a piece of the pie in the streaming market.
The new ad-tier is another sign that Netflix has to innovate to remain as the leader in the streaming space.
There are also worries over the sustainability of its premium pricing with new streaming alternatives.
Strong dollar will hurt earnings
Given Netflix’s international exposure, the strong dollar is negatively affecting its earnings.
As the company reports its earnings in dollars, the strong dollar will result in lower revenue from its international business.
The company’s operating margin will also be affected since most of Netflix’s costs are dollar-based.
Shift towards a more sustainable business model
One of the most significant shifts during the third quarter was the announcement that management will no longer be providing guidance on the number of subscribers from Q1 FY2023 onwards.
This reflects Netflix’s shift towards its financial performance.
The company will continue to provide guidance for revenue, operating income, operating margin, net profit, EPS and fully diluted shares outstanding for the quarter.
I believe this represents the maturity of Netflix as a business and a shift towards a more sustainable business model.
Valuation to remain depressed
While the worst appears to be over for Netflix, downside risks for its share price remain in today’s market environment.
The streaming giant’s share price has already fallen by more than 50% as compared to a year ago but it is still trading at a trailing price-to-earnings (PE) ratio of 28 times.
While it is relatively cheaper than some of its peers, its valuation is likely to remain depressed given the rising interest rate environment and a potential recession in 2023.
Disclaimer: ProsperUs Investment Coach Billy Toh doesn’t own shares of any companies mentioned.
