Datadog Q3 Earnings: Having Déjà vu from Q2

Posted on November 3, 2022June 30, 2026 by io-fund

I was feeling a little bit of Déjà vu on the Datadog call as we got a nearly identical report as Q2. I’m not complaining by any means; a consistent management team that guides conservatively is rare in the environment and exactly what we are looking for.

Our previous write-up from Q2 can be found here.

The price action reversed from +10% in the pre-market to (3%) on the RPO growth of 31% which I discuss below. I’m certain it was when this comment was made and was not due to Q4 growth as that was outlined in the earnings report and had been released for some time with the +10% intact. We had outlined key metrics were “what to watch” so I am not surprised RPO was a hot item in this earnings report.

Notably, the stock price reversed again to about +2.5% when the CFO stated October was strong so far. He is remaining conservative and saying they need to “wait and see” on November and December but analysts (and the market) like it when management provides a glimpse into the current quarter.

Every earnings report right now has something of concern so we make sure to note the areas of concern below. Overall, we are happy with the report yet want to provide a prudent analysis of Q3.

Pre-earnings report write-up can be found here

Q3 Financials:

Revenue this quarter came in at $437 million for 61% revenue growth compared to $414.2 million expected for consensus of 53% revenue growth. This represents 7% growth QoQ.

Many investors on our site have owned Datadog for a while now, and will agree that management has a strong track record of sizable top line beats. Despite has slowing revenue growth of 37% next quarter, but my guess by management using the words “conservative” is that we will have another beat in Q4.

The company provided Q4 guidance of $445 million to $449 million which matches consensus of $447 million for 37% growth. FY2023 Guide of $1.65 billion is higher than estimates of $1.63 billion, which reflects the beat in Q3. This represents growth of 60.5% compared to analyst consensus of 58.4% growth.

GAAP EPS of ($0.08) was a bit softer than previous quarters as referenced by the softer GAAP operating margin.

Adjusted EPS was a beat at $0.23 compared to $0.16 expected. This is in line with previous quarters. The adjusted EPS guide is for $0.19 EPS.

Full year adjusted EPS was raised from a guide of $0.74 to $0.81 to $0.92 EPS as the midpoint.

The company reported GAAP Gross Margin of $324 million or 78.2% compared to GAAP GM of 77% a year ago. This is down 180 basis points from previous quarter margin of 80%.

GAAP Operating Margin was (7%) down from (2%) last year and (1%) last quarter. This led to an operating loss of ($31.3) million. GAAP Net Margin was (5.9%) for net losses of ($25.9) million. The difference in the GAAP margin versus Non-GAAP is the high stock based compensation.

Adjusted operating profit of $75 million with Adj OM of 17% beat management guidance for $53 million and growth of 12.8%. The adjusted net margin was 19% for adjusted net income of $81M.

The company is guiding for adjusted operating profit of $58 million for growth for a margin of 12.8% however it does come out to a (20%) decline in YoY growth in adjusted operating profits, at the midpoint. The company stated the softer YoY adjusted gross margin was due to two large events: the DASH user conference and AWS Re:Invent.

FY2022 guide was raised from a margin of 16.4% to a margin of 18.2% for full year adjusted operating profit of $302 million, at the midpoint.

The company’s operating cash flow of $83.6 million is up QoQ and YoY yet represents a lower operating cash flow margin of 15.5% compared to 18% last quarter and 25% in the year ago quarter.

Free cash flow of $67 million is also up QoQ and YoY yet the FCF margin is a bit softer at 15.3% compared to the 21% reported a year ago and is flat sequentially from 15% last quarter. The company has $738M in debt.

Stock based compensation is a blemish at $101 million or 23% of revenue. This is up from 20.2% of revenue last quarter and up from 16% in the year ago quarter.

Key Metrics:

ARR of > $100,000 customers grew 44% to 2,420 compared to 66% growth a year ago. Last quarter, the > $100,000 cohort grew 54%.

Billings accelerated QoQ to 51% YoY for revenue of $467 million, up from $397 million last quarter and 47% growth in Q2. However, YoY Billings are certainly decelearting from 98% growth or $309M.

RPO decelerated and is a concern. The deceleration we noted in our last earnings report and our pre-earnings write-up where we noted the deceleration went from 85% to 51%. This quarter, the deceleration steepened to 31% year-over-year growth for $941 million. RPO is still up on a sequential basis with $858M in RPO in Q1, $881M in RPO in Q2 and $941M in RPO this quarter. If it were to decline on a QoQ basis, the stock would be deeply penalized, so we will monitor this as we go along.

Regarding RPO, the company said the following:

“As a reminder, we signed several large multiyear renewals in Q3 2021, which may make current RPO, a more useful indicator with — as it excludes the multiyear duration impact. We also had a challenging comparables of that metric as Q3 of last year, current RPO growth was about 100%. We continue to believe revenue is a better indication of our business trends than billings or RPO as those can fluctuate relative to revenue based on the timing of invoices and the duration of customer contracts.”

What the market is worried about is that RPO is forecasting a further decel in FY2023 in revenue growth than what Q4 represents.

The company stated “churn remains low” with retention in the mid to high 90s.

Datadog management emphasizes they are a land and expand model. This is best seen in the key metrics in customer-to-product growth: “At the end of Q3, 80% of customers were using two or more products, up from 77% a year ago. 40% of customers were using four or more products, up from 31% a year-ago and 16% of our customers were using six or more products, up from 8% a year ago.”

Additional Notes:

I’m going to quote a few important things from the call on the two items of most concern which is RPO and Q4 guidance.

Here an analyst asked about the CRPO number (current RPO).

“Brent Thill

And just a quick follow-up on the CRPO. I know David, you mentioned, stay focus on that. It is continuing to decelerate, I guess, is that just a function of the large comps? Are you seeing larger enterprise customers? You've seen a slower cadence of large deals come in. Can you give us your take on that?

David Obstler

Yeah, I think we had — the comps are very significant in this quarter. In Q3 of last year, and I think we said this at the time, we had some large multiyear deals. As a reminder, we don't try to target multiyear deal we had from the client side. So that's why the current probably is more over time correlated. It is also moves. So if you look at the average of this, it tends over the longer time to correlate with revenues, but there's a lot of noise in this number. So we steer everyone back to revenues and then the computation we've given everybody how to convert revenues into ARR.”

Here is what was said regarding Q4 guidance remaining unchanged:

Matt Hedberg

Great. Thanks guys. David, for you. Last quarter, you talked about a stronger July versus June. I'm wondering if you could comment a little bit on how the linearity of the quarter played out, and then maybe also how is — how did October trend relative to September?

David Obstler

Yeah. So we — for linearity, it was very similar linearity to what we've had. There was no difference. And so we saw — unlike last quarter a bit, we saw pretty much of a pro rata type of quarter. And we normally have a strong October in terms of the flow of our customers and what they're doing in the platform before pro freezes. We're pleased with what we have seen so far, but still recognize that October is usually strong for us. And it's only the beginning of the quarter.

Oli, anything else you want to add that?

Olivier Pomel

No, I think the one thing you're trying to get through the over time during the quarter, we exited the quarter pretty much at where we entered it. There's no change there. And again, as David said, we're happy with what we see there, and we're also usually happy with our product.

We — Q4 has a bit more seasonality in other quarters, in particular, December tends to be a little bit weaker as a lot of our customers take time off and sit down their development environment and things in that. It's also been a little bit harder to forecast in recent years with the pandemic and the behavior that — the vacation behavior that change after the pandemic. So we are little bit careful with that, and that's all incorporated in our guidance.

Conclusion:

My main concern with Datadog is not the fundamentals or this report but rather the valuation and where it goes from here. We have DDOG at a current P/S of 17.85 with 20 being the ceiling. We could see 30 P/S if the stars align but I would say 20 is where will return to pretty quickly if that happens. I expect cloud to trade range bound between 15-20 for the top 5 or top 10 until macro clears.

This means 40% growth rate can lead to 40% gains if we assume a constant valuation from 2022 to 2023 and any tech investor would take that right now. However, if we see cloud extending, we may be conservative and trim at times.

Roku: Revenue and EBITDA Miss for Q4

Posted on November 3, 2022June 30, 2026 by io-fund

Q3 was strong in terms of beating on the top and bottom line whereas the Q4 guide was very weak.

In the September quarter, Roku reported revenue of $761 million compared to $696 million expected. This represented 12% growth compared to 2.5% growth expected. On the bottom line, EPS of ($0.88) beat estimates of ($1.29). The company was expected to report adjusted EBITDA of ($75M) and instead reported ($34.4M)

In Q3, Platform revenue was up 15% and player revenue was down (7%). Strangely enough, Player revenue was stronger in Q3 compared to the two previous quarters when it was down (19%).

ARPU grew 10% to $44.25 and the company added 2.3M users. These two key metrics were strong compared to what other ad-tech companies have reported.

Despite the Q3 beat, the Q4 guide was troublesome. Roku was expected to report revenue of $906.6M for growth of 4.77% yet came in over $100M low with a guide of $800M. This represents growth of (7.6%). The adjusted EBITDA guide of ($135M) compares to Q3 adjusted EBITDA of ($34.4M).

I believe this statement is Roku’s admission they got the timing wrong on increasing opex:

“Our significant Q3 OpEx (operating expense) YoY growth was largely the result of robust hiring in late 2021 and early 2022 when we believed that the economy was emerging out of pandemic-related disruptions, and we were accelerating investments that we had previously deferred. We started taking steps to significantly slow the rate of hiring and other OpEx growth in late Q2, however, it will take a few more quarters for this YoY OpEx growth rate to normalize. We will continue to slow headcount and OpEx growth in response to the macro environment, while continuing to make disciplined investments in our most strategic projects that will increase both the market penetration of our platform and long-term customer value.”

Roku believes the scatter market is dropping quickly and they clearly stated it was not unique to them and was industry wide. They stated that advertisers lack confidence in the economy. This is affecting the Q4 guide on revenue. What you see below has essentially worsened for Q4, per Roku’s management.

Here is what was stated:

Anthony Wood

This is Anthony. So we are seeing – like Steve said, there's a lot of uncertainty. It's hard to say exactly what's going to happen in Q4, but we are seeing signs that Q4 is going to be worse in terms of the ad market than Q3 was, I mean we're seeing lots of big categories, pull back telecom, insurance. We're even seeing telemarketers planning on reducing their spend in Q4.

I think traditionally, Q4 is a very – the holiday season is typically the strongest period for a lot of companies, including Roku. But companies are pulling back their ad budgets because they're uncertain if there will be a recession or not. And so a lot of Q4 ad campaigns are being canceled. And so that's why I think this holiday season, given the unique set of environments and characteristics, is probably going to be different than the typical holiday season.

Conclusion:

Due to EBITDA issues, which management has stated “it will take a few more quarters for this YoY OpEx growth rate to normalize” we are looking for an exit. It will be Knox’s choice on how/when this happens given the valuation is already quite low.

When Roku opens tomorrow, it will be a 2 P/S. This is the type of valuation a company has that is going bankrupt or has a near-zero risk. Meanwhile, Roku has $2.02 billion in cash and is reporting ($91.9M) in free cash flow in the first 9 months. It’s unlikely Roku will need to raise next year or the year after. It’s also not isolated in its issues with ad budgets as we’ve seen the concerns around Q4 echoed across nearly every ad-tech company that has reported. The 2 P/S is more reflective of a company that needs to raise cash soon or a company that may go out of business or even a company that has inherent issues not reflected widely in its industry.

I believe we will buy this company again in the future if active accounts and ARPU continues to grow. These are leading indicators for media companies, and Roku will be on our radar quarterly to see when adjusted EBITDA gets sorted.

AMD Q3 Earnings: Data Center is Resilient

Posted on November 2, 2022June 30, 2026 by io-fund

We covered AMD’s pre-announcement in “The One Critical Reason I’m Still Feeling Zen.” The company has a lot of lost ground to recover and I believe it has enough horse power in its product line up to do so.

This was a stronger report than first glance because by guiding flat from Q3 to Q4 for 14% revenue growth, AMD stated data center and embedded will grow sequentially to absorb PC weakness. One analyst mentioned working with a number between $800M to $900M on Client Revenue for Q4, which would be down from $1 billion in Q3. It was also directly stated gaming revenue would be flat sequentially.

Rough Idea of Q4:

$850M Client Segment, at midpoint (hinted at)
$1,600 Gaming (confirmed)
$1,750 Data Center (rough estimate)
$1,350 Embedded (rough estimate)

This would mean sequential data center growth of 9% from Q3 to Q4 compared to 8% sequential growth from Q2 to Q3. Embedded was up 4% sequentially from Q2 to Q3.

I believe the timing of the Genoa product and the glimpse of Meta’s capex means we are setting up for a strong 2023 with data centers. I believe the analysts fully understood this point on the call as PCs were certainly discussed but was not the main focus. Data center discussions had more air time in the Q&A.

Q3 Financials

Most notable from the Q3 report is that the company missed on Q4 revenue guidance with $5.97 billion for growth of 23.8% expected versus $5.5 billion reported for actual growth of 14%. The market shrugged this off as AMD stated data center and embedded would grow year-over-year and sequentially. I believe this was a solid reaction as AMD is becoming a leading AI company and holding the stock hostage to cyclical PC sales is missing the larger picture.

This brought the full year estimates down by $300 million from $23.8 billion to $23.5 billion. This will represent growth of 43% down from 44.9% expected. We can see that PCs will have a $2.8 billion drag on revenue this year as originally revenue was expected to be $26.3 billion.

Adjusted EPS of $0.67 missed estimates of $0.76 adjusted EPS. GAAP EPS was $0.04.

Where AMD had some positive surprises was in the adjusted margins and cash flow. The adjusted GM of 50% is higher than the year ago quarter at 48%. This is also true for Q4’s guide of 51% adjusted GM, which is higher than the year ago quarter at 50%.

The adjusted operating margin was also higher than what we had for expectations. It came in at 23% versus 13% expected and is flat from the year ago quarter. This led to adjusted operating income of $1.3 billion for 20% growth YoY and adjusted net income of $1.1 billion compared to $893 million a year ago for 23% growth YoY. Notably, this is down from $1.7 billion in Q2.

The GAAP GM was at 42% and GAAP OM was at ($64) million and both are lower than usual due to PCs/Client Segment.

The operating cash flow of $916 million is up from $849 million in the year ago quarter and free cash flow of $842 million helped maintain a steady FCF margin of 15%.

Apples-to-apples, I think this was a stronger report than Microsoft’s – a tech titan exposed similarly to PCs – because AMD’s other segments are so strong the company is able to maintain double digit growth of 14% next quarter compared to Microsoft’s low guide of 2%.

Data Center Strength:

This was an important comment regarding cloud spending specifically within the data center segment:

“Cloud revenue more than doubled year-over-year and increased sequentially as multiple hyperscalers expanded deployments of EPYC processors to power their internal properties and more than 70 new AMD instances were launched by Microsoft Azure and Amazon, Tencent, Baidu and others in the quarter.”

Analysts pressed AMD on if they expect 20% to 30% growth in the data center next year but management declined to comment “precisely” this early. Instead, AMD went on to call out North America hyperscale spending as a key driver for next year and mentioned China will not see a significant recovery (similar to 2022).

“Now it varies by segment, and so if I go through each of the segments, what we are seeing is I think North America cloud is, probably, the most resilient out of the segments within the Data Center market and this is where AMD is the strongest […] As we go into 2023, we expect growth in that market, particularly customers moving more workloads to AMD, just given the strength of our product portfolio, and overall, Genoa coming forward.

“Moving more workloads to AMD” = That’s a comment on Intel losing market share. Woohoo! Let’s gooooo!

Below is a notable conversation about how analysts are viewing Big Tech capex and cloud infrastructure growth as a leading indicator for AMD:

Harlan Sur

Great. Thank you. And despite the macro concerns, and as you mentioned, some near-term workload optimization, your North American cloud customers, I mean, they are still growing their cloud services business at a strong 30%, 40% year-over-year growth rate and I assume that these types of growth rates like the consumption of compute networking, storage workloads and therefore, installed utilization, like, this is all quite strong in driving the need to build out more compute capacity. Is this what’s driving the team’s sort of strong mid-term outlook for this segment or is it more a function of your strong product lineup with Genoa and continuing to capture greater compute share or both?

Dr. Lisa Su

Yeah. Right. Harlan, I would say, it’s a little bit of both and I think you said it well. In the very near-term, there is a little bit of optimization that each cloud vendor is doing. But in the medium-term, what our customers are telling us is they need more compute.

And the more compute is for additional workloads building out. It’s also for upgrade of, let’s call it, older compute, given our new products have very strong TCO, power efficiency, given the cost of power and energy around the world. We are actually seeing that also be a driver for some of the conversion to AMD in the cloud as we go into 2023.

Notably, one analyst stated the company missed their model and estimate for data center revenue. The CEO replied this is due to GPUs having a tough comp from last year due to the timing of a high-performance computing release – Frontier Exascale Supercomputer. She also pointed toward lower enterprise revenue.

In addition to Data Center, Embedded was strong and AMD called out 5G infrastructure specifically. I’m hoping this translates well for Marvell.

Information on PC Market for 2023

The data center may be resilient but certainly PCs are weighing on this company. I think this question and answer was important for AMD investors to hear so I’m quoting the conversation.

“Vivek Arya

[…] what does client recovery look like, do you get back to the $2 billion quarterly rate, do you get to $1.5 billion? And I asked that because your competitor was suggesting that next year the PC TAM would only be down 4% or 5%, which seems a little bit optimistic. What do you think AMD is kind of — what kind of PC TAM does AMD have in mind for next year so that we get a sense for how this de-risk the model is from a PC perspective?

Dr. Lisa Su

Yeah. So, a couple of different points, Vivek. Let me just answer the sort of the expectations around Q4. I would say, we are guiding, let’s call it, modestly down for Client and Gaming, and obviously, we are coming off of what is already a low base in Q3. We want to do that to correct the sort of the inventory situation as quickly as possible, and as a result, we are going to under ship consumption again in the fourth quarter to do that.

As it relates to next year, I think, there are a lot of factors. I mean this year PCs will be down quite a bit, let’s call it, high-teens, close to 20%. As we go into next year, I think, the industry is calling mid-single digits. I think that would be a good case. I think we should model down to minus 10%.

And again, within our PC business, we expect as we get through this inventory correction, I mean, we have very good products, and I feel very good about our product portfolio and very good about our platforms overall. So I do think the PC business will recover as we go into 2023, but we will have to work through these dynamics over the next quarter or so.

My translation: Perhaps I am being optimistic but I believe AMD is saying the recovery will happen earlier in 2023 (H1) rather than later in 2023 (H2) per the language chosen and that AMD plans to be on the earlier side within H1 by under shipping in Q4.

Conclusion:

AMD had a better earnings report than Microsoft and a better report than Nvidia is expected to have. These companies are comparable because of the one-time event hitting a non-thesis segment. Where they are not comparable is that AMD’s strongest segments are keeping the company in double digit growth territory.

I like Microsoft and Nvidia very much but it is uncanny how AMD continually finds a way to unexpectedly have a good report. I get to call this stock The Dark Horse for a little longer until it surpasses Intel on the data center; which means the name will likely be retired by 2024.

Netflix Stock Will Be A FAANG Again

Posted on November 1, 2022June 30, 2026 by io-fund

This article was originally published on Forbes on Oct 27, 2022,11:14pm EDTForbes on Oct 27, 2022,11:14pm EDT

Netflix lost it’s status as a FAANG when the stock fell from a $300 billion market cap to a $100 billion market cap this year. My firm entered Netflix in August as we fully expect the stock to become a FAANG again due to its revenue potential from ads and improving cash profile.

Given macro, very few tech companies have a catalyst of any kind on the horizon with many companies in a defensive stance. Netflix, on the other hand, has an offensive plan to grow subscribers and revenue even in the face of macro pressures.

In my free newsletter published on Forbes, I had stated in both June and July: “I would argue the day that Netflix’s stock price dropped 35% was consequently one of the most important days in the company’s history in terms of its chances for a boost in revenue and a renewed uptrend. Patience, though, will be required, as Netflix has work to do.”

My target for the roll-out was originally Q1 to Q2 2023, and instead, Netflix is rolling out the ad supported tier next week. My firm had entered the stock in August with a real-time trade alert, so the surprise 6-month roll-out was welcomed. The ad supported tier will monetize at the same rate or even higher than legacy tiers with a $6.99 monthly subscription combined with a $10 ARPU over time (needs time to ramp to reach this ARPU).

A high probability of revenue acceleration from ad tier combined with improved cash profile combines for an attractive stock for 2023. Not only will Q4 and Q1 provide some clues around the new trajectory but there is an additional catalystan additional catalyst in Q1/Q2. We are reserving details about this lesser known catalyst for our research members.

The biggest names in tech are reporting their earnings right now, and our premium members are getting updates almost daily. Learn more about about our premium membership here.The biggest names in tech are reporting their earnings right now, and our premium members are getting updates almost daily. Learn more about about our premium membership here.Learn more about about our premium membership here.

Netflix is Expected to Return to 2021 Subscriber Growth Levels

Netflix had a sizable beat on subscribers and the stock breathed a visible sigh of relief as the company comfortably beat with 2.4M net adds compared to 1M to 1.2M expected. Consensus for next quarter was 4.1M with Netflix guiding for 4.5M. This will be the largest account growth since Q3 2021.

The largest contributor to growth is the APAC region at 1.4M new subs followed by EMEA at 0.6M subscribers and LatAm at 0.3M subscribers. United States and Canada reported 0.1M subscribers whereas in the past this region saw churn.

Revenue was up 5.9% compared to 4.7% expected. On a constant currency basis, revenue grew 13% YoY.

There is a miss on revenue for next quarter due to FX headwinds. The company guided for 1% growth versus 3.5% growth expected. On a constant currency, Q4 is expected to grow 9%. This creates a slight miss on FY2022 revenue at $31.5 billion guided versus $31.6 billion expected.

The AVOD tier is most likely targeting the 100M who are sharing passwords. Therefore, I believe Q1 is when the stronger results will appear from Netflix’s AVOD entry due to the password sharing being phased out early next year.

Here was the update:

“Finally, we’ve landed on a thoughtful approach to monetize account sharing and we’ll begin rolling this out more broadly starting in early 2023. After listening to consumer feedback, we are going to offer the ability for borrowers to transfer their Netflix profile into their own account, and for sharers to manage their devices more easily and to create sub-accounts (“extra member”), if they want to pay for family or friends. In countries with our lower-priced ad-supported plan, we expect the profile transfer option for borrowers to be especially popular.”

Operating margin came in higher than expected at 19% versus management’s previous guidance of 16%. There was a 4% decline from the previous year due to FX. The company is guiding for an operating margin of 4% to 8% next quarter, or 10% on a constant currency (CC) basis. This is due to seasonal spending on marketing and content, and on a CC basis, will be higher than last year’s 8.20%.

The revenue and operating margin beats flowed through to a net income beat of $1.39B compared to $961M expected.

Operating cash flow was at $557 million and free cash flow came in at $472 million. This means management has made good on its promise to see $1 billion FCF this year. It also implies FCF could be ($287) million next quarter as we are at $1.287 billion for the year.

Netflix reiterated regarding the FCF next year: “We continue to expect FCF of +$1 billion for the full year 2022, plus or minus a few hundred million dollars and substantial growth in FCF in 2023 (assuming no further material appreciation of the US dollar).”

There was a minor improvement in Netflix’s cash and debt levels with cash increasing to $300 million to $6.18B with net debt of $7.98B. This is down from net debt of $8.5B in the previous quarter.

The company had a big beat on EPS of $3.19 versus $2.17 expected. This included a $348 million non-cash unrealized gain from FX remeasurement on Euro denominated debt.

Was the Market Wrong About Netflix Saturation?

Netflix does not believe their market is saturated, rather that advertising opens up a new, sizable addressable market. The company offered the following information: “In the 190 countries in which we operate, our $30 billion-plus of annual revenue is roughly 5% of the combined estimated ~$300 billion pay TV/streaming industry, ~$180 billion branded advertising market, and $130 billion consumers spend annually on gaming. So, we believe that we have a long runway for growth if we can continue to improve our offering steadily over time.”

We had stressed in our previous free newsletter that the lagging discussion on Netflix is that there was a subscriber decline in Q1 of 200,000, excluding Russia and a subscriber decline of 970,000 in Q2. While critics believe this is due to saturation, it’s much more likely the decline is coming from a pull forward due to Covid as all media stocks – both streaming and social media – demonstrated outsized audience growth through Q2 2021. Therefore, Netflix is lapping some tough quarters for audience growth comps and announced in April their plan to have an ad tier to help combat this.

Management’s willness to combat subscriber falloff with an ad tier is why we entered in August prior to the subscriber beat.

Another important point we had highlighted was there is already evidence that Netflix is taking more market share than its peers. In fact, Nielsen raised Netflix’s market share earlier this year for engagement to 7.7% from 6.6%, which puts Netflix in the lead over any other competing subscription service.

Source: Beth Kindig Twitter

Management could not be more clear in their Investor’s Letter or on the earnings call that having the streaming best content in the world is their #1 strategy for success. That is one reason I track statistics such as Netflix’s share of TV time very closely. There was discussion that Netflix fully accepts the cost of creating the content and is instead more focused on getting more value from $1 billion in content than their competitors.

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More on the Ad Tier

Here was the update from Netflix regarding the new ad-supported tier from the Investor’s Note:

“As we’ve been discussing over the past few quarters, improving our pricing strategy is an important near-term focus. Last week, we announced that we’ll be launching an ad-supported subscription plan on November 1 in Canada and Mexico; November 3 in Australia, Brazil, France, Germany, Italy, Japan, Korea, the UK, and the US; and November 10 in Spain. Cumulatively, these 12 markets account for ~$140 billion of brand advertising spend across TV and streaming, or over 75% of the global market.

To start, we’re keeping it simple by offering one low-priced ad plan – Basic with Ads – at a price that’s 20%-40% below our current starting price. So in the US, for example, Netflix will now start at $6.99 per month (compared to $9.99 today). The Basic with Ads plan will have ~5 minutes of advertising per hour, frequency capping and strong privacy protections.”

Netflix has been able to launch its ad platform within 6 months of the announcement. The announcement earlier this month was good news for Netflix investors who entered early despite many institutional analysts predicting it would be six months into 2023 before it rolled out.

Also on the earnings call, management stated they are not expecting any material financial impact this quarter from ads due to the intra-quarter launch. However, over time, the company expects the ad tier to be margin accretive. My personal take is that it can produce a slight boost in subscribers in Q4 and this glimpse is going to be one that I am very much looking forward to. Management has no visibility at this time as it launches in two weeks so it’s prudent to not guide beyond the visibility they currently have.

Summary/Conclusion:

I believe that one day, investors will look back and see that it was a buying opportunity when Netflix went down 35% in April of 2022 after the company announced it’s plans to move into advertising. The goal of the ad tier is address saturation head-on by increasing the addressable market.

Netflix beat on revenue, subscribers, operating margin, and free cash flow in the recent Q3 results with small improvements from Q2 across the board in what may have marked the bottom for this company. The Q4 guide is also in-line across the board.

The company is expected to be free cash flow positive this year. Netflix has only been FCF positive in 2020 and has not been FCF positive in any other previous year. The company also lost $3.3 billion in 2019 when it built its original content pipeline. The stock will now enter two years of FCF positive between 2022 and 2023.

Advertisers are likely to pay a high premium for Netflix’s Hollywood-level content. Notably, it was recently revealed Netflix plans to only have 5 minutes of advertisements which is why the ARPU target is $10, however, that comes out to a target of $16.99 per user with the $6.99 pricing tier.

It’s not only the 100 million people sharing passwords that illustrates what the uptake could be for a lower-priced tier, it’s also the high level of engagement the company’s content garners that could make for a nice equation for with demand from exclusive advertisers and supply from the premium content, that Netflix offers.

Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own Netflix at the time of writing.