Netflix (NASDAQ:NFLX) had a reasonably good Q3 2022 quarter, with overall results exceeding both management’s internal prediction and market expectations. However, I continue to have reservations about Netflix’s long-term prospects, given the increasing competition and how well it can execute its ad-supported model to reaccelerate growth and fund its operations in the long run, as well as the impact of churn due to the monetization of password sharing.
Netflix stock has fallen nearly 55% year-to-date but has risen by about 25% in the past six months.
Overview of Netflix Earnings and Previous Events
Netflix had a good Q3 2022 quarter, exceeding its earlier guidance by adding 2.42 million new customers, much beyond its previous guidance of 1 million. This was partly due to its comparatively underserved APAC market, which attracted over 1.4 million members. Its operating margin was 19.3%, which was in line with forecasts. Without the effect of foreign currency exchange, its revenue would have increased by 13% year on year. Given that it had its first subscriber loss and its first-ever single-digit growth rate in Q1 2022, this is a good quarter. While this is true, I am concerned about Netflix’s long-term trajectory.
Netflix’s business model depends on its capacity to reinvest in fresh content to attract new viewers and maintain existing users on its platform. However, as competition heats up and the cost of content rises, Netflix finds itself striving to strike a balance between raising rates and maintaining its existing plans affordable for its subscribers. As a result, it embarked on a few critical initiatives in Q1 2022 to reaccelerate its growth rates:
- The introduction of a lower-priced ad-based plan to monetize ads.
- Crackdown on and monetize users who use password sharing.
- A focus on reinvesting in new content to entice and retain users.
My Concerns About Netflix’s Increasing Competition
As the largest streaming platform, I feel Netflix has an advantage over its competitors. This is partly because Netflix can use customer analytics to determine which types of content are more likely to be well-received by viewers. While this is true, I believe the competitive dynamic has shifted dramatically due to the rise of numerous new streaming channels.
This could imply that (1) marketing efficiency may deteriorate as streaming platforms compete for market share, and (2) there may be more pressure on the need to reinvest extensively in new content in conjunction with the previously indicated rising cost of content. This casts doubt on Netflix’s ability to maintain its long-term operating margin of 19%. Furthermore, competitors like Disney (NYSE:DIS) and Amazon (NASDAQ:AMZN) have valuable properties and strong internal financing to fund their operating deficits.
Cannibalization of Existing Subscribers and Ad-Supported Model Execution Risks
On the other hand, creating a new ad-based plan carries risks since price-conscious customers may transfer from existing plans to a lower-priced ad-based plan to save money, causing Netflix to cannibalize its existing subscriber base. Here’s what management said at the Q3 2022 earnings call:
“…consumer-facing price will bring in a lot more members then we’re quite confident in the long term that this will lead to a significant incremental revenue and profit stream…we don’t see a lot of members switching plans…But then again, the economics and the revenue will be fine as a result even if some of those consumers switch plans.”
Because these ad-based programs have yet to be offered, it is unclear how many of its existing subscriber bases will convert to lower-priced plans. According to a recent survey, lower-tier users are likelier to switch to a lower-cost ad package. According to management, these losses will be offset by additional subscribers resulting from the new ad strategy and high-margin revenue from commercials. Recently, it was also claimed that all of Netflix’s ad inventories were sold out, indicating that advertisers were eager to reach out to Netflix users.
Having said that, it remains to be seen how well Netflix can run its ad-supported strategy, which poses a significant execution risk. Keep in mind that, with a cap on its price increase and fierce competition, Netflix’s future viability is contingent on the execution of its ad-supported strategy to sustain its operations in the long run.
Users Are Irritated by Monetizing Password Sharing
As Netflix prepares to commercialize users that use password sharing to reaccelerate its growth rates, consumers have expressed their desire to terminate their memberships online. Until this is accomplished, my other concern is the churn rate and the impact on the company’s bottom line. I believe this will affect price-conscious and lower-tier subscribers.
Should You Buy Netflix Stock?
This is a brief post about Netflix, but it contains some of the primary worries I have about its long-term growth. However, I recognize that Netflix had a relatively good quarter. I wouldn’t invest more in Netflix stock now, but I’m keeping my shares.
Featured Image – Megapixl © Twindesign
