Netflix‘s second-quarter earnings results can be interpreted in two very different ways. The company’s future depends on which reading turns out to be correct.
The world’s biggest streaming company announced Tuesday that it lost nearly 1 million subscribers for the three-month period from April to June, marking the second straight quarter it lost customers. Still, that was less than the loss of 2 million the company had forecast and Netflix shares were up about 6% at $214 in midday trading Wednesday.
The second-quarter results offer a new bull case for Netflix investors. If the quarter serves as a “bottom” — the point at which Netflix stopped losing subscribers and started growing again, even if at a snail’s pace — investors have a new growth story. In the next quarter, Netflix forecast it would add 1 million subscribers. This may be the primary reason shares rose on Wednesday.
“With signs of stabilization in the subscriber base emerging, we believe the prospect of a prolonged period of subscriber losses is becoming increasingly unlikely,” Stifel analyst Scott Devitt said in a note to clients. Stifel upgraded its rating on Netflix shares to “buy” on Wednesday.
But the results, which some investors found good enough, may only lead to temporary relief. The bear case for Netflix is that Wednesday’s bump in share value is a “dead cat bounce” − Wall Street lingo for a temporary recovery after a substantial fall. Netflix faces intensifying competition from major players pushing into the streaming market, including Disney’s Disney+, NBCUniversal’s Peacock and HBO Max. That has raised questions about whether Netflix will be able to hold onto its dominance, particularly in the lucrative U.S. market.
The new case for growth
Previously, Netflix bulls have leaned in to the notion that the company would turn its massive global scale of 221 million subscribers into positive free cash flow by increasing pricing and reducing churn. This transformation from a money-losing venture to a free cash flow machine would enrich shareholders.
That’s now happened, or, at least, is about to happen. Netflix said in its shareholder letter it will generate $1 billion in free cash flow for 2022. In 2023, Netflix said there will be “substantial growth” in free cash flow.
And yet, Netflix shares are still trading 70% lower than all-time highs set in November.
A second wave of subscriber growth could be the company’s new narrative for investors. There’s reason to believe Netflix subscribers will once again surge ahead. Netflix announced it will crack down on password sharing and launch a cheaper advertising supported tier in 2023. Both of those initiatives may lead to more signups.
End of its heyday
If Netflix’s subscriber growth doesn’t reaccelerate, the second quarter of 2022 will serve as the inflection point when it became apparent the company’s halcyon days were over.
“Where do its sub losses end, given strong competition from newer, lower-priced, deeper-pocketed, streaming services?,” wrote Needham analyst Laura Martin. “222 million global subs may turn out to be the peak subscribers for Netflix.”
This may prove to be the case if Netflix can’t turn enough of its password sharers into long-term paying subscribers. Netflix said in its shareholder letter that’s it’s encouraged by its early learnings from tests in Latin America that it can convert password-sharers to paying customers.
In Tuesday’s conference call, Netflix Chief Financial Officer Spencer Neumann said the company planned to spend about $17 billion on content in 2022 and would stay in that “zip code” for the next “few years.” That’s a change from nearly every year in the past decade, when Netflix has ramped up content spending to build its market share. As its revenue growth has slowed, Neumann acknowledged spending on new programming will also moderate.
“Our content expense will continue to grow, but it’s more moderated as we adjusted for the growth in our revenue,” said Neumann.
It remains to be seen if Netflix can continue to grow its subscriber base without an ever-ballooning content budget — especially since the company typically raises prices each year. The worry is particularly stark in the U.S. and Canada, where Netflix lost 1.3 million subscribers in the second quarter, marking the third quarter in the last five when its customer base has declined.
“Given the risk of elevated churn with every price hike from here, the realistic worry is that the company will be hard pressed to materially re-accelerate growth in these regions,” said Michael Nathanson, an analyst at research firm MoffettNathanson.
In coming years, investors may look back on this year’s second quarter as the moment Netflix either began its second growth act or its slow migration into a value stock.
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