Netflix is done with shrinking quarters

I love Netflix’s drama, Extraordinary Attorney Woo, where it shines the spotlight on a young lawyer with Asperger’s syndrome. This is one of the most popular drama series this year, on top of other hits such as Squid Game and Stranger Things.

Hence, I am not surprised when Netflix has re-discovered its mojo this quarter. The firm announced strong subscriber growth of 2.4 million in 3Q2022, blowing past expectations of 1 million.

The market loves the robust subscriber growth numbers, with the shares price of Netflix surging 13.1% yesterday.

Here are my insights:

• No more shrinking quarters
• New revenue driver of low-price ad-tier subscription
• Headwinds from the strong US dollar

No more shrinking quarters

Netflix has de-rated this year due to concerns on subscriber growth. For the first two quarters this year, subscriber growth was negative, with a total loss of 1.2 million customers.

Hence, there was a massive reprieve when Netflix announced 2.4 million subscriber growth in 3Q2022. Even Chairman Reed Hastings demonstrated a sign of relief when he mentioned that “thank God we’re done with shrinking quarters.”

The main growth driver came from the Asia-Pacific region, making up more than half of the subscriber growth. The Asia Pacific region alone witnessed an astounding increase of 1.4 million. Asia clearly loves Extraordinary Attorney Woo.

Furthermore, the subscriber growth is not a one-off. Netflix guided that there will be a further 4.5 million subscriber growth next quarter. This is almost double the subscriber growth this quarter.

New revenue driver of low-price ad-tier subscription

Netflix is planning to roll out a low-priced ad-tier offering next year. In exchange for 5 minutes of advertisement, users can access to Netflix at $7 each month. This is about half of its standard subscription fee of $15.49 per month.

This is a great strategic move.

It will reduce subscriber churn. With an affordable pricing of $7, it will discourage users from cancelling their Netflix subscription. Also, such low pricing will lower the barrier for new users to subscribe to Netflix.

Netflix’s move to lower price is in direct contrast to its competitor, Disney.

In my previous article, I argued that Disney’s move to raise prices will likely backfire. Disney has increased its ad-free subscription fee to $10.99 per month. The old $7.99 pricing will now be laden with commercials. See the article below

As Disney has yet to release its latest quarterly results, it remains to be seen if their subscriber growth will slow down. However, the strong subscriber growth of Netflix could be a sign that it is taking market share away from Disney. In the United States and Canada (UCAN) region alone, Netflix registered an increase of 100,000 subscriber growth, beating expectations of a decrease of 271,376.

Headwinds from the strong US dollar

The strong US dollar will be a drag on Netflix’s earnings.

More than half of Netflix’s total revenue (56%) lies outside the UCAN region. Its second largest operating region is in Europe, Middle East and Africa (EMEA) which constitutes 31% of its total revenue, and their currencies have dropped against the US dollar.

Netflix has acknowledged that a strong US dollar will impact its earnings. The firm estimates that there will be a negative impact to their full year 2022 revenue and operating income of $1 billion and $0.8 billion respectively.

Also, Netflix has lowered its earnings guidance despite stronger subscriber growth. It now expects revenue of $7.78 billion in 4Q 2022, below the $7.98 billion market expectations. EPS is expected to be slow at $0.36, about a third of the $1.2 expected by market.

In terms of valuation, Netflix is trading at a forward P/E of 28.5x, near its 3-year mean of 29.0x. Earnings growth is expected to be slow at 4%. This implies that Netflix’s valuation is not cheap. 

Hence, I'd only consider buying Netflix on pullback.

The article is contributed by EdNeverSlumber. You can read more of his investment insights on his substack.