Source: Netflix filings
Netflix kicked off entertainment industry earnings season with a bang and a lot of news late Tuesday, with Wall Street analysts dissecting its second-quarter results, outlook and commentary overnight.
After its shock first-quarter subscriber loss, the fact that the global streaming giant lost 970,000 subscribers instead of the predicted 2 million in the second quarter — which included the launch of season 4 of original hit show Stranger Things — drew much focus. The same was true for its forecast for a third-quarter return to growth to the tune of 1 million subscribers.
The company, led by co-CEOs Reed Hastings and Ted Sarandos, now has 220.67 million subscribers, and still leads the race among all streaming giants. But details about content spending — which execs said would stay around the annual $17 billion level — and an announcement that Netflix would release its advertising-supported, cheaper subscription tier “around the early part of 2023” attracted much interest and debate across Wall Street.
Overall, investors initially seemed to give Netflix’s results, forecasts and commentary a positive reception, with the stock gaining in after-hours and early in Wednesday pre-market activity. But in early trading, as of 9:35 a.m. ET, the stock was only up 1.4 percent at $204.41.
However, analysts response was more mixed. Some financial observers expressed relief about the results and argued that management was taking control of the company’s narrative again. Others warned that new business initiatives would take time to bear fruit and underlined the challenges for reaccelerating subscriber growth in mature and maturing markets — such as the U.S., Canada and Europe — meaning that investors should for now stay on the sidelines.
After many analysts cut their stock price targets, along with subscriber and financial forecasts, on Netflix after the company’s first-quarter earnings report, this time, most stuck to their current ratings and targets though.
Credit Suisse analyst Douglas Mitchelson broke that mold. While he maintained his “neutral” rating on Netflix, he cut his price target from $360 to $263 “due to a more conservative long-term forecast.” “Uncertainty remains elevated for Netflix with subscriber growth stalled post-pandemic and (management) focusing on improving monetization via charging for password sharing and broadening the service’s value proposition through lower-priced ad tiers,” he explained. While he sees “some promise” in the new strategic initiatives, he emphasized that they “will take at least well into 2023 to prove out (and perhaps into 2024 to drive meaningful revenue reaccelerating).”
Many others also noted both the positive and the challenging in their notes to investors. Case in point was Macquarie analyst Tim Nollen’s report with the title “A Little Light Relief.” “Some stability in subs is good, and management’s tone sounded much more reassured this time than the last two; so, Netflix stock could enjoy a short relief rally,” he argued. “But there is still some way to go to turn numbers around, while sub adds are only tracking to flat through the third quarter, and we don’t know what the effect of a recession may be on subs.”
He also highlighted management comments that content spending would likely stabilize at the current annual $17 billion level. “This could be good for earnings and free cash flow, but will compare with rising spending on all other streaming services that will bring a flood of even more content competition,” Nollen warned.
Others were similarly torn between the bullish and the sobering in Netflix’s results and commentary. “Still Recovering But Now Pain Free,” summarized Wells Fargo analyst Steven Cahall the state of Netflix and maintained his $300 price target and “equal weight” rating. He slightly raised his 2022 subscriber growth estimate from 2.4 million to 2.5 million, while leaving his 2023 forecast unchanged at 7.8 million.
“Content is always the heart of the stock,” he highlighted in digging deeper into the streamer’s user trends, as well as content spending and strategy. “We think Netflix scaling its content spend so quickly and widely, with impressive velocity in deliveries globally, may have meant that the quality suffered. From here, the company is notably looking to improve efficiency and efficacy. Cash content spend should stay in the $17-$18 billion zip code per year, while we think Netflix is looking to improve how it gets spent. This improves free cash flow, but potentially creates some risk against competitors with growing content war chests.”
Cahall also argued that the worst could be over for the stock for now, if all goes well. “We think Netflix has found a bottom assuming sub growth doesn’t hit any new cliffs. Next year, new initiatives will start to contribute, and it’s reasonable to expect that the Netflix of 2024 and beyond will have very healthy top- and bottom-line growth and better free cash flow. There’s enough risk and wood to chop between here and there that we don’t want to step in amidst a lot of execution risk. But, for long-term GARP (growth at a reasonable price) investors, we think downside risk is now much more limited.”
In fact, Cahall said the company’s “transition gaining momentum” and noted stock gains in after hours. “We think this quarter will mark the beginning of a new GARPy Netflix taking shape and bucked the recent trend,” he concluded. “Fourth-quarter 2021 results abruptly showed cracks in the armor of sub growth, while the first quarter of 2022 was worrisome as new strategies were just emerging. Now those initiatives are starting to take shape, and while it’s too early to visualize the company’s longer-term financial complexion, which keeps us happier on the sidelines, we think the recent pain is over. We see the positive earnings reaction as indicating a bottoming in sentiment.”
Evercore ISI analyst Mark Mahaney, who has an “in line” rating and $245 price target on the streaming giants’ stock, also shared this take on the company and investors’ approach following its recent challenges. “Netflix is a great company and a great service. And this management team has demonstrated both extraordinary industry vision and the ability to pivot successfully,” he wrote, noting that “there are a lot of positives here for the global streaming leader.” But he also highlighted: “We believe the market will need to see real success from the ad-supported and password-sharing initiatives before ascribing a sustainably premium multiple to Netflix.”
Others joined him in addressing the theme of investor sentiment. “The market compressed Netflix’s multiple last quarter in part because its strategy evolution seemed rushed,” wrote BMO Capital Markets analyst Daniel Salmon. “This quarter, management delivered a much better explanation of its new points of focus, including advertising and password sharing/’add a home.’ But first and foremost, both second-quarter actual and third-quarter guidance for subs/members were good enough.”
Guggenheim’s Michael Morris echoed that sentiment. In his report, entitled “Management Regains Footing, Pitches Position Strength and Initiative Progress,” he wrote: “Key opportunities in advertising and password sharing are taking shape, though still early. Notably, the company’s ambitious pursuit comes with spend discipline, with annual cash content spend of around $17 billion in ‘the right ZIP code’ for the next several years.”
Maintaining his “buy” rating and $265 price target on the stock, while increasing his free cash flow forecast, Morris concluded: “We continue to see attractive value and optionality in Netflix shares.”
Salmon also discussed Netflix’s free cash flow trajectory, lauding that “the free cash flow outlook had more color added: from ‘consistently free cash flow’ positive to $1 billion in 2022 and ‘substantial growth in 2023.’ Street free cash flow consensus of $1.7 billion in 2023 seems likely to move higher,” Salmon concluded in reiterating his “outperform” rating with a $365 target price.
Neil Begley, analyst at Moody’s Investors Service, also expressed confidence in free cash flow trends. Netflix’s better-than-expected second-quarter subscriber momentum “provides confidence that Netflix will grow net subs and generate solid free cash flow in 2022 despite the post-COVID slowdown and continuing foreign exchange headwinds, respectively,” he said. “The strong content slate and solid engagement in 2022 should position the company well to ramp up its alternative revenue drivers, including password sharing fees and advertising in 2023 and beyond.”
Meanwhile, Cowen’s John Blackledge stuck to his “outperform” rating and $325 price target, but discussed the sub trends in more details. “The third-quarter sub guide of 1.00 million net adds was below our and consensus net adds of 3.32 million and 1.81 million, but came in above a conservative buyside bogey and amid relatively low expectations,” he wrote in a report. “We believe a likely return to growth will be viewed favorably, particularly if the trend continues through year-end (Netflix should be helped in the fourth quarter by strong seasonal trends and a robust content slate.”
PP Foresight analyst Paolo Pescatore also shared his read of Netflix’s sub momentum and how the planned ad tier would affect it. “While the last set of results was a bombshell, this quarter was much better than expected with lower subs losses. However, (there are) still concerns with lower subs growth for the third quarter compared to the same period last year,” which saw the addition of 4.4 million users, he said. “This comes at a crucial time given the cost of living crisis having a profound impact on all companies; no one is immune, with consumers all feeling the pinch and tightening their belts.”
With Netflix adding its ad tier, Pescatore warned: “Netflix needs to tread carefully not to cannibalize its own base, while working closely with brands to serve relevant ads. This is all based on Netflix taking a more open approach to the wealth of data its has built on customer behavioral patterns.”
Meanwhile, in one of the most pessimistic reports, Pivotal Research Group analyst Jeff Wlodarczak reiterated his “sell” rating on Netflix and cut his target price by $60 to $175. “In our view, the most prudent move for Netflix management is actually to look to sell the company, with recent advertising partner Microsoft (which lacks a streaming product) the most logical partner.”
He argued latest results were “mostly disappointing,” noting that the lower-than-feared second-quarter sub loss “appears mostly driven by higher than forecast low average revenue per user (low-value) India subscriber growth.” He also pointed out “worse than expected third-quarter subscriber guidance of +1.0 million (even with the ‘benefit’ of low-value India subs) versus our 1.8 million forecast.”
Wlodarczak is also bearish on the planned ad-supported subscription tier. “The entrance into ad-supported Netflix is likely to not increase subscriber growth in core markets (given increased competition and what appears to be full U.S./Canada penetration) and could actually push down average revenue per user (as certain core subscribers churn down to what we believe will be lower ad-supported average revenue per user) exacerbated by a likely competitive response.”