Welcome to the newly launched Essentials Plan, we are glad you are here. We launched Essentials on the Thanksgiving holiday weekend and we will be ramping content on a weekly basis.
Below, I discuss our buy plan on Netflix which is briefly described in the 7-minute video below. We began building our position for our premium members around $217, and since have provided 4 buy recommendation, all of which are positive, as of this writing. We think Netflix is going to be a leading stock in 2023, which Beth outlined in the December stock pick found here.
I use a blended approach of technical analysis to determine our portfolio entries and also to pre-determine our risk management. Risk management is a key part of owning tech stocks and I share this with you in the video.
Netflix is a 10% allocation, at time of writing, which is quite high for us. We have taken some gains as we approach a pullback in the markets, and plan to buy more in the near future. In this video, I discuss the levels we plan to execute our trades in the video below.
The I/O Fund built a position in Netflix with real-time trade alerts starting with an entry at $220.71 on August 30th and at $255.08 on November 7th.
After seeing gains of 43.8% from the first entry and gains of 24.4% from the second entry, Knox then trimmed some of the position to take profits.
For our Essentials Members, Knox will release a private video next week that discusses our plan for building this position and/or our plans to take profits in the future. This video will be similar to the information provided above regarding our positioning but will be forward-looking on what entries we plan to do next OR if we plan to trim and add again at a later time.
Below, is a fundamental analysis on Netflix including the specific reason that Q1 and Q2 could be “the quarters” for Netflix to become a stock market darling.
Please note: We are not financial advisors and our disclosure regarding this is at the bottom of the article.
Our goal is to do the following:
Provide you with a December stock pick that we believe may be the top stock of 2023. We want to give you information around the specific catalysts we are expecting in Q1 and again in Q2 that has made Netflix a buy off the August lows.
We want to provide real investment tools to our Essentials members by providing the same level of technical analysis we use for our portfolio and we use on the Advanced Market Signals service to time entries and exits. This includes allocations (the #1 tool for risk management) and will be provided early next week on a recorded video presented by Knox, the I/O Fund portfolio manager.
We do not think blanket BUY recommendations are helpful as the market is tumultuous and complex. We are real investors and everything we do is actionable for stock investors. The material you receive on this site is anchored to real decisions we are making with our own portfolio. If it’s not impactful, we will not write the content or produce the video. This is different than other sites that simply fill content pipelines to “get something out” so their customers are satisfied. This is why we believe we offer some of the highest quality content across research sites — the content is being used for real investment decisions and there is zero fluff.
Background on Netflix in 2022:
Below is a brief overview of Netflix’s ad opportunity before we discuss the specific catalysts coming in Q1 and Q2 of 2023.
Netflix’s stock was down a staggering 71% this year. The stock’s fall from grace included dropping its FAANG-status as the company’s market cap has decreased from $300 billion to $75 billion. This was partly due to the company reporting it lost subscribers for the first time since 2011, with a loss of 200,000 subscribers in the most recent quarter. The company also forecast a decline of 2 million paid subscribers for the second quarter.
The earnings report caused the stock to lose 35% of its value over night. Bill Ackman sold his Netflix shares for a loss of $450 million in three months, with some critics goading him for his decision while others congratulated Pershing Capital for being bold and walking away from a losing position.
Meanwhile, our focus was elsewhere.Meanwhile, our focus was elsewhere.
In our Netflix coverage following its earnings report, we had stated “we can’t help but salivate” over which ad platform Netflix might choose to power ads to hundreds of millions of viewers. Primarily, this is because we have consistently discussed why the trend of CTV ads has plenty of runway even during an epic market selloff.
In other words, 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. We prefer to get in front of the market instead of wait for the market to put the pieces together on what this global juggernaut is setting up to do.
The path to adding more subscribers is finally clear for Netflix and will pay off in 2023 especially during times of inflation or muted consumer confidence as it drives down household costs across fragmented subscriptions.
Ad-Supported Video on Demand (AVOD)
The acronyms AVOD and CTV ads (connected TV) should be added to your investment vocabular as this is the most investable trend in media today. Ad-supported video on demand (AVOD) refers to streaming subscription services that supplement with ads or streaming services that are entirely ad-supported. CTV ads are often synonymous with AVOD, however, it can also refer to Broadcast Video on Demand (BVOD) for when live broadcast content is streamed over the internet.
Mobile ads have flatlined yet AVOD is in its early stages of growth. This will become especially apparent during times of economic hardship as subscribers trim back on their many streaming subscriptions and turn to ad-supported content to drive down costs.
We had written an editorial a year ago on Forbes called the Crucial Difference between Netflix and Roku Stock. At the time, we pointed out that: “we believe first-party data for connected TV ads is a significant trend moving into 2021 and an important distinction from subscription-video on demand (SVOD) […] Ad-Video on Demand (AVOD) has an approximate ten-year runway as the trend began taking shape when Roku launched its ad platform in late 2018/early 2019. There were AVOD players in the space before this, but the budgets were negligible.”
Why was mobile capable of capturing such large budgets? Because of first-party data which traditional TV lacks. CTV ads are also capable of capturing large budgets because advertisers are willing to pay more for targeted ads.
Due to your viewing habits, Netflix knows a lot about you. Selling this to advertisers emulates more closely the level of ad demand a company like Facebook would see, who also powers ads with behavioral-level data.
The Market Mistakenly Thinks Netflix is Saturated
There is immense opportunity when a stock investor can prove the market is wrong about a company. With Netflix, a leading line item that investors must be confident on is that the company can grow its user base.
Netflix is tied with YouTube on total viewing time but there’s a catch. Netflix has only 223 million subscribers and YouTube has over 2 billion due to its digital video app. For most purposes, these two are not truly competitors, rather YouTube is a hybrid between a social mobile app and a CTV streaming service. YouTube TV has a mere 5 million subscribers.
What matters most to advertisers is time spent watching content and Netflix clearly wears the crown in the streaming wars.
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 coverage 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 willingness 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.
Q3 Netflix Earnings Results:
Netflix comfortably beat earnings estimates 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.
Why Q1 is Critical for Netflix’s 2023 Stock Trajectory
There are two chess moves on the table that can help propel Netflix to become a leading stock in 2023. The first is the moment when Netflix simultaneously cuts off password sharing while having the ad-supported tier available to the customers being cut off from sharing accounts.
Netflix has an estimated 100 million rogue subscribers who are sharing passwords with friends and family members. It’s this cohort of 100 million password sharing fans that the ad-supported tier is squarely aimed at converting.
Let’s look at what management has said:
“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.”
Translation: In early 2023, Netflix is going to cut off the 100 million and offer them two options: 1) pay to be an extra member on the family plan or 2) export your profile, keep your viewing data, and pay for a lower priced ad-supported plan.
Patience from investors is required because Netflix is the first tech company in our universe to report every quarter. Netflix will not have this rolled out for the Q1 guide coming in mid-January but we do believe it will show up by the full quarter Q1 report in April with an informed guide for Q2.
The Second Chess Move is called The Upfront Season
Every year, advertisers and agencies negotiate and sign year-long deals with TV networks as well as connected TV platforms to commit to spend an agreed amount on ads. They call this the upfront season. Last year, NBCUniversal clocked $7 billion in the upfront season and Roku grew it’s upfront spend from$500 million to $1 billion.
The 2023-2024 upfront season will take place in the late Spring and early summer of 2023.
Netflix is a $30 billion company and so something along the lines of a $7 billion upfront may seem small. However, if you go back to the Nielsen pie chart that shows viewing time, you’ll see that NBCUniversal doesn’t even make the list, representing less than 1% of viewing time. Disney makes the list at 1.9% and had a $9 billion upfront season.
I won’t give you an exact number on what this upfront season will pull for Netflix as their AVOD subscriber base will not be mature yet. Meaning, it may be more in the category of the lower percentage streaming services on the ad-supported side. What matters is that even a $7 billion or $9 billion up front (let’s think positive here based on the comps) would result in a 20%+ boost in revenue.
If the two chess moves line up, they will both be a strong statement the market is wrong on Netflix’s saturation. the market is wrong on Netflix’s saturation.
Netflix is trading a historic low on both its sales valuation and earnings-based valuations. However, is now the time to buy or is it better to wait for a renewed uptrend? We fully believe the single most important time to buy is when the broad market participates (Nasdaq, S&P 500).
Next week, Knox Ridley will record a special Netflix webinar for you as part of your Essentials package going over Netflix’s technical setup in detail so our Essentials Members are as informed as possible.
As you know, we can’t control the market – what we can do is tell you what we do with our money including when we buy/sell/add/trim and why.
Look for that YouTube video published on our Essentials site next week.
Thank you for being a Founding Member to our Essentials Plan. We officially launched the plan last week are excited for this new tier to our analysis.
Disclosure: 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. The I/O Fund owns Netflix at time of writing.
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.
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.
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.
Please note, we will be writing up pre-earnings notes on the forum for the stocks we own. You can access Netflix’s pre-ER here.
Highlights:
No major flags in the earnings report
For Q3, the company beat on subscribers, revenue, operating margin and free cash flow
Q4 guide is in-line across the board. Next quarter will see lower operating margin due to seasonality
The new ad supported tier rolls out in two weeks; we believe this is an underappreciated catalyst. The ad supported tier will monetize at the same rate or even higher than legacy tiers with $6.99 monthly subscription combined with $10 ARPU over time (needs time to ramp to reach this ARPU).
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 we will also keep an eye on the upfront season in April/May.
The company is still trading well below its 5-year historic valuation
Financials:
Netflix had a sizable beat on subscribers and the stock is breathing 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.
The largest contributor to growth is the APAC region at 1.4M new subs followed by EMEA at 0.6M subs and LatAm at 0.3M subs. United States and Canada reported 0.1M subs 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. As was the case last quarter, the market is willing to overlook FX headwinds.
As we’ve covered in the past, I continue to believe revenue growth is too low for the upcoming ad tier and the roll-out of how to phase out password sharing.
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.”
Per our Pre-ER notes, analysts are expecting $10 ARPU from the 5 minutes of advertising when it’s fully rolled out, which puts this tier on par with other tiers for revenue growth.
Password sharing is being leveraged by 100 million viewers. Here was Netflix’s update on how they plan to monetize these users:
“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.
For our position, this being reiterated regarding FCF next year is key: “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 $3.10 versus $2.17 expected. This included a $348 million non-cash unrealized gain from FX remeasurement on Euro denominated debt.
A Few More Points:
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 gaming6. So, we believe that we have a long runway for growth if we can continue to improve our offering steadily over time.”
Early next month, Netflix goes live with its new ad-supported tiers. 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.
Here is what we had stated: “It’s certainly feasible that strong ad partners can get Netflix’s global rollout accomplished in a year’s time – which is why I believe we will hear who Netflix has chosen as soon as Q2 earnings or by Q3 earnings. I don’t think we will need to wait until Q4 2022 as testing is likely to happen sooner.” — this timing is important not only because as investors we don’t have to wait too long to get a glimpse of the impact of the new ad tier (Q4 earnings) but also because this sets up Netflix for next year’s upfronts.
I foresee Netflix doing quite well during next year’s upfront season, which is when prepaid inventory is contracted between high-paying brand advertisers and media companies. Assuming there are no changes, we fully expect to hold our position well into this time frame (Q2 2023). This is primarily because Netflix has very high-quality content and because Pay TV advertisers are in some pain right now with the need to find strong content to place ads.
On the earnings call, management discussed the “collapse of Pay TV” stating they had underappreciated the effects that the Pay TV migration is having on advertisers. They specifically pointed to the 18-49 year old demographic.
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 nice boost in subscribers 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.
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 the creating content and is instead more focused on getting more value from $1 billion in content than their competitors.
Conclusion:
Given the new ad tier and the popularity of password sharing, I believe Netflix’s revenue estimates over the next few quarters and next fiscal year are quite low. When you combine this with a new cash profile for Netflix, this stock may be entering the perfect storm. Netflix has only been FCF positive in 2020, and has not been FCF positive in any other previous year. We will now be entering two years of FCF positive between 2022 and 2023.
This article was originally published on Forbes on Jul 22, 2022,01:44pm EDTForbes on Jul 22, 2022,01:44pm EDT
Netflix is trading at a 10-year historic low valuation, which means this is an opportune time to discuss the pros and cons of this stock should there be upside potential.
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.
Netflix management was clear that this quarter was “less bad” as they hinted the company is not exactly celebrating the results. The company technically returns to growth next quarter for subscribers with a guide of 1 million, yet this is a marked decline from the 4.4 million in the year ago quarter. As discussed, due to the overall impact across many media stocks from shelter-in-place, it would be hasty to believe there’s something inherently wrong with an individual company when the entire media industry was affected. It’s better to hold those conclusions until H2 2022 through H1 2023 after giving it a full year after tough Covid comps have cleared. Ultimately, media is very seasonal, and we should have a nice glimpse as to which companies emerge stronger by Q4 2022, as this is the strongest quarter seasonally.
With that said, there is already evidence that Netflix is taking more market share than its peers. In fact, Nielsen is raising Netflix’s market share for engagement to 7.7% from 6.6%, which puts Netflix in the lead over any other competing subscription service. This is due to high-quality content such as Stranger Things 4, which reported 1.3 billion hours streamed.
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Advertisers are likely to pay a high premium for Netflix’s Hollywood-level content. 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 industry-leading ARPU due to demand from exclusive advertisers coupled with the supply, or premium content, that Netflix offers.
Due to FX headwinds, Netflix missed on revenue in the most recent quarter at 9% revenue growth compared to 9.7% expected. However, on a constant currency basis, revenue growth was 13%. The same was true for Netflix’s guide, it was a miss due to FX headwind at 4.7% for the upcoming Q3 quarter, yet on a constant currency basis, it is a 12% guide on revenue and a beat in that regard.
Not surprisingly, the operating margin was also affected by the strong dollar at 20% in the current quarter and 16% for Q3. The strong dollar led to a slightly better EPS as Netflix saw a $305 million unrealized gain from F/X remeasurement on Euro debt.
The most important line item for Netflix is the company’s cash flow. Looking back, this has been troublesome for Netflix as the company lost $3.3 billion in cash in 2019 as it built up its original content pipeline. However, the company is on an entirely new trajectory with $1 billion in free cash flow expected this year and “substantial” free cash flow in 2023, per Netflix management.
The new and improved trajectory in free cash flow won’t change the company’s debt levels anytime soon. Netflix is firmly setting expectations for $10 to $15 billion in debt into the foreseeable future. This is necessary to continue to hold its place as the top media company in terms of revenue and engagement. Gross debt stands at $14.3 billion, when accounting for $5.8 billion in cash, net debt is at $8.5 billion. The company has been able to improve its cash content spend-to-content amortization ratio from 1.6X to 1.4X in 2021 and an expected 1.2-1.3X in 2022.
NETFLIX’S Q2 2022 INVESTOR LETTER
Forward-Looking Catalysts:
Netflix has a few new paths to monetization and to re-accelerate subscriber growth. The company is rolling out a new password-sharing plan and is also now partnered with Microsoft on ads to roll out in 2023. More time than not, cross-selling results in higher revenue where someone who would normally churn can now be monetized through ads. Likewise, viewers who can try out Netflix may decide to upgrade to remove ads. Ultimately, the move towards ads also helps Netflix to be more recession-proof in the event households decide to cut costs.
Risks:
We do not see the current soft subscriber numbers as a sign of saturation. Netflix has risen in market share over the past year. Instead, soft subscriber numbers are a result of the pull forward nearly all media companies experienced from Covid. We fully expect Netflix will return to normal subscriber growth due to the catalysts listed above.
Instead, the primary risk for Netflix is its debt in a rising rate environment. This may depress the company’s valuation more than its ad-tech peers who have strong cash flow and little to no debt during tougher macro conditions. Netflix cannot temper this debt if it intends to compete against other subscription streaming services and also the many broadcast networks that have migrated to streaming.
There is also execution risk with a pivot from subscription-only to also including the ad tier. We view the Netflix management team as perhaps the most capable in the industry of pulling off this pivot as they have consistently broken ground in areas much more challenging than introducing ads. In addition to this, CTV ads can monetize at $40 ARPU and we believe Netflix content will set a new record on ARPU. With that said, even if the execution risk is lower than it would be with other management teams, Netflix is likely to fetch a higher valuation after its proven the ad tier will be successful – ETA of H2 2023.
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What to Watch: Price Action for Netflix Stock
The big picture question to ask is – has NFLX put in THE bottom? There are 3 scenarios that could unfold from the current price range, that would help us manage risk around this question:
I/O FUND
Red: If NFLX breaks below $185, the odds favor one more low, which would be targeting the $147-$115 region. If this happens, it greatly reduces the odds that NFLX will see new highs in the next growth cycle.
Orange: The current swing up breaks above $250. If this happens, the odds favor a push into the $340-$405 region. If this scenario is playing out, we would see the uptrend stall in this region in a bear market rally. The same lower price targets would hold in this scenario.
Green: If any renewed uptrend can break above $405, the odds will shift towards a move to all-time highs.
Netflix bottomed in May while the rest of the market went on to make a new low. More times than not, stocks that bottom first, tend to lead into the next uptrend. This is a show of strength worth monitoring.
We only have 3 waves down from the 2021 high. This may not seem significant, but it is. If this 3-wave move down turns into 5 waves down (red scenario), the odds that we push deep into the orange range are low before the next leg down.
The Relative Strength Index (RSI) has reclaimed a significant level. Note the blue arrow on the RSI around 57. This was the spot where price topped just before the waterfall moment happened in this bear market. The fact that the recent push higher has reclaimed this level is a show of strength and an early sign that green/orange is likely playing out.
Conclusion: The odds favor a push into the $340-$405 region. As long as the next dip holds $185, the more aggressive play would be to buy into that dip. A safer play would be to wait for the breakout above $250.
Knox Ridley, Portfolio Manager at the I/O Fund, contributed to this article.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
This article was originally published on Forbes on Jun 24, 2022,01:43am EDTForbes on Jun 24, 2022,01:43am EDT
Netflix’s stock is down a staggering 71% year-to-date. The stock’s fall from grace includes dropping its FAANG-status as the company’s market cap has decreased from $300 billion to $75 billion. This was partly due to the company reporting it lost subscribers for the first time since 2011, with a loss of 200,000 subscribers in the most recent quarter. The company also forecast a decline of 2 million paid subscribers for the second quarter.
The earnings report caused the stock to immediately lose 35% of its value. Bill Ackman sold his Netflix shares for a loss of $450 million in three months, with some goading him for his decision while others congratulated Pershing Capital for being bold and walking away from a losing position.
Meanwhile, our focus was elsewhere. In our Netflix coverage following its earnings report, we had stated “we can’t help but salivate” over which ad platform Netflix might choose to power ads to hundreds of millions of viewers. Primarily, this is because we have consistently discussed why the trend of CTV ads has plenty of runway even during an epic market selloff.
The key point is this: the global juggernaut in media is essentially stating that CTV ads are the future for streaming.
Below, we discuss why a new perspective is needed as the 200,000-miss last quarter and the 2 million miss this quarter pales in comparison to the 100 million viewers who are sharing passwords that Netflix intends to monetize. In other words, 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 (minimum one to two years for full global roll-out). Yet the path to adding more subscribers is finally clear for Netflix and will pay off long-term especially during times of inflation or muted consumer confidence as it drives down household costs across fragmented subscriptions.
Netflix’s Q1 Earnings
The company reported revenue of $7.9 billion, up 10%. Excluding FX headwinds, the revenue growth in the quarter was 14%. The company guided for 10% growth in the upcoming quarter for $8.05 billion in revenue. Net cash from operations was up from $777 million to $923 million.
Netflix has maintained a healthy operating margin above 20% for most quarters and EPS beat estimates at $3.53 compared to $3.75 EPS a year ago. However, the issue with Netflix has been the lumpy free cash flow since the company began producing original content with the majority of the company’s history being deep in the red on cash flow. The recent quarter was positive $802 million, yet the company still holds gross debt of $14.6 billion on the balance sheet and net debt of $8.6 billion.
Netflix reported a subscriber miss of 200,000, yet excluding Russia, the company had net adds of 500,000 as Russia contributed to a miss of 700,000. Regardless, it’s the upcoming quarter that has the market concerned as Netflix is guiding for a loss of 2 million subscribers.
Notably, Netflix has moved towards staggered releases of hits such as Stranger Things, which could reduce churn and help renew subscriber strength.
Netflix Entering the Ad-Supported Market
We had written an editorial a year ago on Forbes called the Crucial Difference between Netflix and Roku Stock. At the time, we pointed out that: “we believe first-party data for connected TV ads is a significant trend moving into 2021 and an important distinction from subscription-video on demand (SVOD) […] Ad-Video on Demand (AVOD) has an approximate ten-year runway as the trend began taking shape when Roku launched its ad platform in late 2018/early 2019. There were AVOD players in the space before this, but the budgets were negligible.”
During the most recent earnings call, Netflix’s management team discussed the company’s plan to introduce ad-supported content:
“And one way to increase the price spread is advertising on low-end plans and to have lower prices with advertising. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription.And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription.
But as much I'm a fan of that, I'm a bigger fan of consumer choice. And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”
Although Reed Hastings stated “the next year or two,” the New York Times later reported that Netflix told employees an ad-supported tier could rollout by the end of 2022. There were also rumors that Netflix may buy Roku, yet upon hearing the news, we quickly refuted this idea on Twitter:
Netflix’s debt load is one reason why it’s unlikely Netflix will buy Roku as the company has a current valuation of $12 billion. This would nearly double Netflix’s debt or the company could dilute shareholders which would weigh heavily on a stock already down 70% YTD. Plus, Netflix has its hands full as a content creator competing with Hollywood, which was referenced on the call: “We've been doing this for a decade. Well, first of all, that's about 90 years less timethat's about 90 years less time than all of our competitors have been at it.”
Here’s How Netflix Stock Could Make a New High
If Netflix pulls off the feat of making a new high, fundamentally it will need to be correlated to the global roll-out of ad-supported content. I anticipate the company will test an ad-supported tier in lower yielding markets before rolling it out in the United States and Canada where the company has an additional 30 million it can monetize. Due to the testing this is required, UCAN region is unlikely to see a roll-out in 2022, rather look for this in H2 2023.
On a technical level, Netflix is the only other FAANG, along with Google, that has not made a lower low. There are always two paths a stock can take: going lower or going higher. The probabilities improve that a certain direction is favored once a stock breaks specific price targets. The below chart is tracking the 5-wave move from the 2012 low.
What we will want to see for Netflix to make a new high is a break above $405. At this point, the odds are in the stock’s favor that the bulls are in control again. Typically, after a stock reaches new highs, it has to be monitored again to make sure the price holds. If this happens, we will revisit our analysis – which is published weekly in our free newsletter.
Because we deal with probabilities in the sentiment-driven tech sector, it’s also important to point out that below $115 is what we call no man’s land, where a bottom may be particularly tough to form. We call it “no man’s land’ when a stock can potentially be in free fall and we avoid even the best fundamental stories in these zones.
The chart above shows rare, bullish divergences in the chart which would point towards $450 being more probable than a break in support at $115. There are only two other times since 2012 that this pattern has manifested, and they both marked a turning point was close.
Netflix is also trading at a 10-year record for a low valuation, which sets up the stock for a sizable rebound. In fact, the company has not traded this cheap in terms of PE Ratio for over 10 years.
When you look at top line growth, the company has not traded this cheap since 2012:
Notably, Netflix must curtail content costs while competing in a market with many big players. However, despite the nominal subscriber miss, Netflix has actually gained market share from 6% to 6.4%.
Conclusion:
Ultimately, the market has read the situation wrong as Netflix is going to monetize nearly 50% more subscribers in the near-term (1-2 years). The ARPU from advertising is unlikely to be as high yielding as the subscription tiers, yet premium CTV content sees $40 in average revenue per user. We think Netflix could set a new record on ad-supported ARPU due to its premium content and captive audience. Despite a clear path to drive record revenue and record active accounts, the stock is trading at its lowest valuation on the top line and bottom line in 10 years.
My firm’s preference is to wait until we are closer to the ad-supported tier rollout before considering a position in Netflix. When we do enter positions, we issue real-time trade alerts to our Members and publish deep dive analysis to accompany the entries we make. Please consult with your financial advisor on any stock trades you make.
It will be interesting to discuss someday how Netflix’s share price dropped 35% following the news of an ad-supported tier. The stock price took a historic hit after the company reported a subscriber miss of 200,000 and a guide of 2 million subscriber losses for the next quarter. Meanwhile, the company has a surplus of 100 million viewers sneaking passwords that the company can monetize. In my opinion, the market has lost perspective of the bigger picture.
There are two analysts who have started to crunch numbers on the opportunity and they believe it will add a base case of $12 billion in annual revenue and up to $25 billion to $35 billion in annual revenue by 2030.
“Assuming a domestic launch in the first quarter of 2023 and a global rollout over the following two years, Morris has layered in an advertising-supported tier to his multi-year forecast for Netflix and now sees total company revenue approaching $75B by 2030, he tells investors.”
Currently, Netflix is at $29 billion in annual revenue. So, wow — a doubling of Netflix’s revenue in 8 years compared to the nearly 25 years it took to get to the first $30 billion in revenue (Netflix launched in 1997).
There’s been plenty of rumors around who Netflix might choose as an ad server and supply side partner. One reason we think Roku is a candidate is because of its strong positioning with first-party data that can augment Netflix’s publisher data for enhanced targeting. Roku can also make deals around promoting Netflix on its platform, which it did for Disney, since Roku’s ad platform is the primary product compared to The Roku Channel. We think this is a strong possibility because Roku has the richest first-party data in the industry due to owning the operating system where it hosts many applications.
On the other hand, Google is not a good choice as it’s a major publisher itself. YouTube TV happens to be Netflix’s closest competitor in terms of total US TV time at 5.7% and 6.4%, respectively. It’s rare to see Big Tech competitors’ partner with one another, which can result in helping the competitor become stronger. Even though there are rumors that Netflix and Google are meeting about ads at Cannes, those events usually have meetings between all major players without any guarantee of an outcome.
Pictured Above: YouTube is Netflix’s biggest competitor
Magnite has been floated around, and this could be a strong choice for its global exposure and its ad server, SpringServe, helps put the company on par with Roku’s ad server. Comcast’s FreeWheel could also make a good partner for Netflix as the company focuses more on live broadcast and is not in direct competition to Netflix’s premium content.
We think it’s less likely that Netflix goes with The Trade Desk as a publisher, — although certainly anything could happen. However, The Trade Desk will benefit from the increased ad inventory from a demand perspective.
Truly, no matter what ad platform Netflix chooses, more than one CTV ad stock will participate as programmatic allows bidding across many sources to increase fill rates. Due to Netflix’s premium inventory, however, the company may go with a private marketplace where only two or three sources are allowed to bid.
In regards to timing, I foresee Netflix wanting to take full advantage of next year’s upfront season, which means testing and rollout will need to happen by this time next year. Otherwise, Netflix risks losing out on contracts from premium advertisers due to timing and will need to wait until the following year Q2 2024. It’s certainly feasible that strong ad partners can get Netflix’s global rollout accomplished in a year’s time – which is why I believe we will hear who Netflix has chosen as soon as Q2 earnings or by Q3 earnings. I don’t think we will need to wait until Q4 2022 as testing is likely to happen sooner.
Why is that important? Because the global juggernaut has the ability to raise the tide of all boats on CTV ads. This is the biggest news to happen to the CTV ad industry – ever, really, due to the sheer size of audience that Netflix is capable of bringing to the CTV market. There will be a compounding effect as Netflix’s entry will also more ad budgets, more premium advertisers, — and really marks the moment when CTV ads are being taken seriously even by subscription services.
I wrote an article on Netflix published in Forbes below. Of course, the real angle here is that we own Roku and Magnite and we hope one of these two is chosen as the premiere partner. It’s not speculation to say so, rather it’s taken quite a bit of conviction in the face of a fickle stock market to repeat that CTV ads have a large runway ahead of them. Four years and two years later, respectively, from our first analysis and we now have Netflix agreeing with the CTV-ads thesis. I think we should take a moment to let that sink in – as there is no company bigger or more important to agree at this juncture.
If we enter Netflix, it would be above the $450 price target outlined below. The majority of our bullishness resides with the companies we already own and our research is more about the effects on our current positions.
Netflix Stock Could Rally with Ad-Supported Content
Netflix’s stock is down a staggering 71% year-to-date. The stock’s fall from grace includes dropping its FAANG-status as the company’s market cap has decreased from $300 billion to $75 billion. This was partly due to the company reporting it lost subscribers for the first time since 2011, with a loss of 200,000 subscribers in the most recent quarter. The company also forecast a decline of 2 million paid subscribers for the second quarter.
The earnings report caused the stock to immediately lose 35% of its value. Bill Ackman sold his Netflix shares for a loss of $450 million in three months, with some goading him for his decision while others congratulated Pershing Capital for being bold and walking away from a losing position.
Meanwhile, our focus was elsewhere. In our Netflix coverage following its earnings report, we had stated “we can’t help but salivate” over which ad platform Netflix might choose to power ads to hundreds of millions of viewers. Primarily, this is because we have consistently discussed why the trend of CTV ads has plenty of runway even during an epic market selloff.
The key point is this: the global juggernaut in media is essentially stating that CTV ads are the future for streaming.
Below, we discuss why a new perspective is needed as the 200,000-miss last quarter and the 2 million miss this quarter pales in comparison to the 100 million viewers who are sharing passwords that Netflix intends to monetize. In other words, 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 a lot of work to do (minimum one to two years for full global roll-out). Yet the path to adding more subscribers is finally clear for Netflix and will pay off long-term especially during times of inflation or muted consumer confidence as it drives down household costs across fragmented subscriptions.
Netflix’s Q1 Earnings
The company reported revenue of $7.9 billion, up 10%. Excluding FX headwinds, the revenue growth in the quarter was 14%. The company guided for 10% growth in the upcoming quarter for $8.05 billion in revenue. Net cash from operations was up from $777 million to $923 million.
Netflix has maintained a healthy operating margin above 20% for most quarters and EPS beat estimates at $3.53 compared to $3.75 EPS a year ago. However, the issue with Netflix has been the lumpy free cash flow since the company began producing original content with the majority of the company’s history being deep in the red on cash flow. The recent quarter was positive $802 million, yet the company still holds gross debt of $14.6 billion on the balance sheet and net debt of $8.6 billion.
Netflix reported a subscriber miss of 200,000, yet excluding Russia, the company had net adds of 500,000 as Russia contributed to a miss of 700,000. Regardless, it’s the upcoming quarter that has the market concerned as Netflix is guiding for a loss of 2 million subscribers.
Notably, Netflix has moved towards staggered releases of hits such as Stranger Things, which could reduce churn and help renew subscriber strength.
Netflix Entering the Ad-Supported Market
We had written an editorial a year ago on Forbes called the Crucial Difference between Netflix and Roku Stock. At the time, we pointed out that: “we believe first-party data for connected TV ads is a significant trend moving into 2021 and an important distinction from subscription-video on demand (SVOD) […] Ad-Video on Demand (AVOD) has an approximate ten-year runway as the trend began taking shape when Roku launched its ad platform in late 2018/early 2019. There were AVOD players in the space before this, but the budgets were negligible.”
During the most recent earnings call, Netflix’s management team discussed the company’s plan to introduce ad-supported content:
“And one way to increase the price spread is advertising on low-end plans and to have lower prices with advertising. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription.
But as much I'm a fan of that, I'm a bigger fan of consumer choice. And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”
Although Reed Hastings stated “the next year or two,” the New York Times later reported that Netflix told employees an ad-supported tier could rollout by the end of 2022. There were also rumors that Netflix may buy Roku, yet upon hearing the news, we quickly refuted this idea on Twitter:
Netflix’s debt load is one reason why it’s unlikely Netflix will buy Roku as the company has a current valuation of $12 billion. This would nearly double Netflix’s debt or the company could dilute shareholders which would weigh heavily on a stock already down 70% YTD. Plus, Netflix has its hands full as a content creator competing with Hollywood, which was referenced on the call: “We've been doing this for a decade. Well, first of all, that's about 90 years less timethat's about 90 years less time than all of our competitors have been at it.”
Here’s One Path to How Netflix Can Make a New High
If Netflix pulls off the feat of making a new high, fundamentally it will need to be correlated to the global roll-out of ad-supported content. I anticipate the company will test an ad-supported tier in lower yielding markets before rolling it out in the United States and Canada where the company has an additional 30 million it can monetize. Due to the testing this is required, UCAN region is unlikely to see a roll-out in 2022.
On a technical level, Netflix is the only other FAANG, along with Google, that has not made a lower low. There are always two paths a stock can take: going lower or going higher. The probabilities improve that a certain direction is favored once a stock breaks specific price targets. The below chart is tracking the 5-wave move from the 2012 low.
What we will want to see for Netflix to make a new high is a break above $405. At this point, the odds are in the stock’s favor that the bulls are in control again. Typically, after a stock reaches new highs, it has to be monitored again to make sure the price holds. If this happens, we will revisit our analysis – which is published weekly in our free newsletter.
Because we deal with probabilities in the sentiment-driven tech sector, it’s also important to point out that below $115 is what we call no man’s land, where a bottom may be particularly tough to form. We call it “no man’s land’ when a stock can potentially be in free fall and we avoid even the best fundamental stories in these zones.
The chart above shows rare, bullish divergences in the chart which would point towards $450 being more probable than a break in support at $115. There are only two other times since 2012 that this pattern has manifested, and they both marked a turning point was close.
Netflix is also trading at a 10-year record for a low valuation, which sets up the stock for a sizable rebound. In fact, the company has not traded this cheap in terms of PE Ratio for over 10 years.
When you look at top line growth, the company has not traded this cheap since 2012:
Despite the low valuation, Netflix now has a path to monetizing 50% more subscribers (100 million) including 30 million in the United States and Canada that are currently sharing passwords.
Notably, Netflix must curtail content costs while competing in a market with many big players. However, despite the nominal subscriber miss, Netflix has actually gained market share from 6% to 6.4%.
Conclusion:
Ultimately, the market has read the situation wrong as Netflix is going to monetize nearly 50% more subscribers in the near-term (1-2 years). The ARPU from advertising is unlikely to be as high yielding as the subscription tiers, yet premium CTV content sees $40 in average revenue per user. We think Netflix could set a new record on ad-supported ARPU due to its premium content and captive audience. Despite a clear path to drive record revenue and record active accounts, the stock is trading at its lowest valuation on the top line and bottom line in 10 years.
It will be interesting to discuss someday how Netflix’s share price dropped 35% following the news of an ad-supported tier. The stock price took a historic hit after the company reported a subscriber miss of 200,000 and a guide of 2 million subscriber losses for the next quarter. Meanwhile, the company has a surplus of 100 million viewers sneaking passwords that the company can monetize. In my opinion, the market has lost perspective of the bigger picture.
There are two analysts who have started to crunch numbers on the opportunity and they believe it will add a base case of $12 billion in annual revenue and up to $25 billion to $35 billion in annual revenue by 2030.
“Assuming a domestic launch in the first quarter of 2023 and a global rollout over the following two years, Morris has layered in an advertising-supported tier to his multi-year forecast for Netflix and now sees total company revenue approaching $75B by 2030, he tells investors.”
Currently, Netflix is at $29 billion in annual revenue. So, wow — a doubling of Netflix’s revenue in 8 years compared to the nearly 25 years it took to get to the first $30 billion in revenue (Netflix launched in 1997).
There’s been plenty of rumors around who Netflix might choose as an ad server and supply side partner. One reason we think Roku is a candidate is because of its strong positioning with first-party data that can augment Netflix’s publisher data for enhanced targeting. Roku can also make deals around promoting Netflix on its platform, which it did for Disney, since Roku’s ad platform is the primary product compared to The Roku Channel. We think this is a strong possibility because Roku has the richest first-party data in the industry due to owning the operating system where it hosts many applications.
On the other hand, Google is not a good choice as it’s a major publisher itself. YouTube TV happens to be Netflix’s closest competitor in terms of total US TV time at 5.7% and 6.4%, respectively. It’s rare to see Big Tech competitors’ partner with one another, which can result in helping the competitor become stronger. Even though there are rumors that Netflix and Google are meeting about ads at Cannes, those events usually have meetings between all major players without any guarantee of an outcome.
Pictured Above: YouTube is Netflix’s biggest competitor
Magnite has been floated around, and this could be a strong choice for its global exposure and its ad server, SpringServe, helps put the company on par with Roku’s ad server. Comcast’s FreeWheel could also make a good partner for Netflix as the company focuses more on live broadcast and is not in direct competition to Netflix’s premium content.
We think it’s less likely that Netflix goes with The Trade Desk as a publisher, — although certainly anything could happen. However, The Trade Desk will benefit from the increased ad inventory from a demand perspective.
Truly, no matter what ad platform Netflix chooses, more than one CTV ad stock will participate as programmatic allows bidding across many sources to increase fill rates. Due to Netflix’s premium inventory, however, the company may go with a private marketplace where only two or three sources are allowed to bid.
In regards to timing, I foresee Netflix wanting to take full advantage of next year’s upfront season, which means testing and rollout will need to happen by this time next year. Otherwise, Netflix risks losing out on contracts from premium advertisers due to timing and will need to wait until the following year Q2 2024. It’s certainly feasible that strong ad partners can get Netflix’s global rollout accomplished in a year’s time – which is why I believe we will hear who Netflix has chosen as soon as Q2 earnings or by Q3 earnings. I don’t think we will need to wait until Q4 2022 as testing is likely to happen sooner.
Why is that important? Because the global juggernaut has the ability to raise the tide of all boats on CTV ads. This is the biggest news to happen to the CTV ad industry – ever, really, due to the sheer size of audience that Netflix is capable of bringing to the CTV market. There will be a compounding effect as Netflix’s entry will also more ad budgets, more premium advertisers, — and really marks the moment when CTV ads are being taken seriously even by subscription services.
I wrote an article on Netflix published in Forbes below. Of course, the real angle here is that we own Roku and Magnite and we hope one of these two is chosen as the premiere partner. It’s not speculation to say so, rather it’s taken quite a bit of conviction in the face of a fickle stock market to repeat that CTV ads have a large runway ahead of them. Four years and two years later, respectively, from our first analysis and we now have Netflix agreeing with the CTV-ads thesis. I think we should take a moment to let that sink in – as there is no company bigger or more important to agree at this juncture.
If we enter Netflix, it would be above the $450 price target outlined below. The majority of our bullishness resides with the companies we already own and our research is more about the effects on our current positions.
Netflix Stock Could Rally with Ad-Supported Content
Netflix’s stock is down a staggering 71% year-to-date. The stock’s fall from grace includes dropping its FAANG-status as the company’s market cap has decreased from $300 billion to $75 billion. This was partly due to the company reporting it lost subscribers for the first time since 2011, with a loss of 200,000 subscribers in the most recent quarter. The company also forecast a decline of 2 million paid subscribers for the second quarter.
The earnings report caused the stock to immediately lose 35% of its value. Bill Ackman sold his Netflix shares for a loss of $450 million in three months, with some goading him for his decision while others congratulated Pershing Capital for being bold and walking away from a losing position.
Meanwhile, our focus was elsewhere. In our Netflix coverage following its earnings report, we had stated “we can’t help but salivate” over which ad platform Netflix might choose to power ads to hundreds of millions of viewers. Primarily, this is because we have consistently discussed why the trend of CTV ads has plenty of runway even during an epic market selloff.
The key point is this: the global juggernaut in media is essentially stating that CTV ads are the future for streaming.
Below, we discuss why a new perspective is needed as the 200,000-miss last quarter and the 2 million miss this quarter pales in comparison to the 100 million viewers who are sharing passwords that Netflix intends to monetize. In other words, 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 a lot of work to do (minimum one to two years for full global roll-out). Yet the path to adding more subscribers is finally clear for Netflix and will pay off long-term especially during times of inflation or muted consumer confidence as it drives down household costs across fragmented subscriptions.
Netflix’s Q1 Earnings
The company reported revenue of $7.9 billion, up 10%. Excluding FX headwinds, the revenue growth in the quarter was 14%. The company guided for 10% growth in the upcoming quarter for $8.05 billion in revenue. Net cash from operations was up from $777 million to $923 million.
Netflix has maintained a healthy operating margin above 20% for most quarters and EPS beat estimates at $3.53 compared to $3.75 EPS a year ago. However, the issue with Netflix has been the lumpy free cash flow since the company began producing original content with the majority of the company’s history being deep in the red on cash flow. The recent quarter was positive $802 million, yet the company still holds gross debt of $14.6 billion on the balance sheet and net debt of $8.6 billion.
Netflix reported a subscriber miss of 200,000, yet excluding Russia, the company had net adds of 500,000 as Russia contributed to a miss of 700,000. Regardless, it’s the upcoming quarter that has the market concerned as Netflix is guiding for a loss of 2 million subscribers.
Notably, Netflix has moved towards staggered releases of hits such as Stranger Things, which could reduce churn and help renew subscriber strength.
Netflix Entering the Ad-Supported Market
We had written an editorial a year ago on Forbes called the Crucial Difference between Netflix and Roku Stock. At the time, we pointed out that: “we believe first-party data for connected TV ads is a significant trend moving into 2021 and an important distinction from subscription-video on demand (SVOD) […] Ad-Video on Demand (AVOD) has an approximate ten-year runway as the trend began taking shape when Roku launched its ad platform in late 2018/early 2019. There were AVOD players in the space before this, but the budgets were negligible.”
During the most recent earnings call, Netflix’s management team discussed the company’s plan to introduce ad-supported content:
“And one way to increase the price spread is advertising on low-end plans and to have lower prices with advertising. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription. And those who have followed Netflix know that I've been against the complexity of advertising and a big fan of the simplicity of subscription.
But as much I'm a fan of that, I'm a bigger fan of consumer choice. And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”And allowing consumers who would like to have a lower price and are advertising-tolerant get what they want makes a lot of sense. So that's something we're looking at now. We're trying to figure out over the next year or two. But think of us as quite open to offering even lower prices with advertising as a consumer choice.”
Although Reed Hastings stated “the next year or two,” the New York Times later reported that Netflix told employees an ad-supported tier could rollout by the end of 2022. There were also rumors that Netflix may buy Roku, yet upon hearing the news, we quickly refuted this idea on Twitter:
Netflix’s debt load is one reason why it’s unlikely Netflix will buy Roku as the company has a current valuation of $12 billion. This would nearly double Netflix’s debt or the company could dilute shareholders which would weigh heavily on a stock already down 70% YTD. Plus, Netflix has its hands full as a content creator competing with Hollywood, which was referenced on the call: “We've been doing this for a decade. Well, first of all, that's about 90 years less timethat's about 90 years less time than all of our competitors have been at it.”
Here’s One Path to How Netflix Can Make a New High
If Netflix pulls off the feat of making a new high, fundamentally it will need to be correlated to the global roll-out of ad-supported content. I anticipate the company will test an ad-supported tier in lower yielding markets before rolling it out in the United States and Canada where the company has an additional 30 million it can monetize. Due to the testing this is required, UCAN region is unlikely to see a roll-out in 2022.
On a technical level, Netflix is the only other FAANG, along with Google, that has not made a lower low. There are always two paths a stock can take: going lower or going higher. The probabilities improve that a certain direction is favored once a stock breaks specific price targets. The below chart is tracking the 5-wave move from the 2012 low.
What we will want to see for Netflix to make a new high is a break above $405. At this point, the odds are in the stock’s favor that the bulls are in control again. Typically, after a stock reaches new highs, it has to be monitored again to make sure the price holds. If this happens, we will revisit our analysis – which is published weekly in our free newsletter.
Because we deal with probabilities in the sentiment-driven tech sector, it’s also important to point out that below $115 is what we call no man’s land, where a bottom may be particularly tough to form. We call it “no man’s land’ when a stock can potentially be in free fall and we avoid even the best fundamental stories in these zones.
The chart above shows rare, bullish divergences in the chart which would point towards $450 being more probable than a break in support at $115. There are only two other times since 2012 that this pattern has manifested, and they both marked a turning point was close.
Netflix is also trading at a 10-year record for a low valuation, which sets up the stock for a sizable rebound. In fact, the company has not traded this cheap in terms of PE Ratio for over 10 years.
When you look at top line growth, the company has not traded this cheap since 2012:
Despite the low valuation, Netflix now has a path to monetizing 50% more subscribers (100 million) including 30 million in the United States and Canada that are currently sharing passwords.
Notably, Netflix must curtail content costs while competing in a market with many big players. However, despite the nominal subscriber miss, Netflix has actually gained market share from 6% to 6.4%.
Conclusion:
Ultimately, the market has read the situation wrong as Netflix is going to monetize nearly 50% more subscribers in the near-term (1-2 years). The ARPU from advertising is unlikely to be as high yielding as the subscription tiers, yet premium CTV content sees $40 in average revenue per user. We think Netflix could set a new record on ad-supported ARPU due to its premium content and captive audience. Despite a clear path to drive record revenue and record active accounts, the stock is trading at its lowest valuation on the top line and bottom line in 10 years.
When Beth Kindig first wrote about Roku in 2018 (here and here), sentiment towards this then-unpopular stock was not in line with her primary thesis. At best, investors were hesitant. The primary arguments against her thesis were: 1) Roku will get eaten alive by Big Tech, 2) The company is undercapitalized to expand, 3) It’s a glorified hardware play, 4) Roku has no moat.
Here are some examples of the comments made on her analysis back in 2018, which characterized the prevailing sentiment at the time:
“ROKU's model doesn't make money. The minute they try to force others to pay a fee, Google's android system will take their customers. And don't forget, Google, Amazon and Apple have voice control of the tv and can search the web for weather and sports. ROKU cannot beat these big boys.”
“The problem I see with ROKU is that they have yet defined how exactly they are going to differentiate themselves from the big boys. If push comes to shove and my amazon prime membership gives me a free firestick or my 5 apple devices means I get 50% off apple TV why on earth would I choose a stand-alone platform? Assuming they will be able to drive margins up through advertising is a tough sell for me.”
“I love Roku, but right now, it is a hardware company on par with Sonos, while Netflix is a content provider that is spending $12bn on content. Netflix needs to be looked at as a tech company though.”
After the March 2020 selloff, hesitation resumed around the Roku Channel and the company’s earnings. Investors now complained that Roku’s earnings were moving in the wrong direction due to lower margins and its OTT channel was no competition for the already popular and crowded space in OTT.
Today, some investors are worried that the stock’s best days are behind it. Below we reexamine our long thesis for Roku, and look at the technicals to determine what might be next for the stock.
The Future of Connected TV
Beth firmly believes Roku is benefitting from a trend that has more room to run: OTT and Connected TV Ads. In the U.S., connected TV ad spending is projected to increase from $8.11 billion this year to $18.29 billion in 2024, according to eMarketer.
Normally, it would be a concern that the overall growth is declining – yet Roku owns the majority of programmatic connected TV market with 46% of ad spend on Roku connected devices. This is followed by about 10% market share Samsung, Apple and Amazon each. There is also a 47% increase in Roku apps that support programmatic compared to 13% in Amazon Fire TV apps.
We believe Roku’s leadership will continue on a global scale, which is not accounted for in these statistics.
The power of these misunderstood microtrends are the reason why many investors missed out on Netflix and can’t understand how a company with such “terrible fundamentals” isn’t collapsing. The market simply doesn’t understand tech and that’s to our advantage.
The OTT/Connected TV ad microtrend is what propelled Roku to a recent high of $486 on Feb.16, and it’s the reason why we identified several buying opportunities within this correction.
We think the strength of an analyst is determined by how accurate their thesis is and the sooner they get the thesis right, the more likely they will continue to get it right. Our original thesis continues to play out today: an agnostic, ad platform that supports the migration of Pay-TV ad dollars through first-party data and a strong operating system. The company is also expanding globally which will be its first attempt at doubling TAM.
I have personally watched Beth hold her original thesis through many bouts of investor doubt and market volatility, as is common with the tech growth stocks she builds a conviction around. Her conviction regarding Roku is how we were able to build the bulk of our position with a cost basis of $28. Her conviction is also how we have been able to weather the volatility to be up more than 1000% as of April 1.
Today, some investors are worried that Roku’s best days are behind it. We believe it’s best to follow the analyst who got it right from the beginning.
Below we go over current technicals, where you’ll see we are well aware of when a stock is extended and also when it’s bottoming, which can provide a good opportunity to build a position. While many traders attempt to sell at the top and buy at the bottom (wash and repeat), we prefer to remain steady with our convictions so our readers trust us and can rely on our convictions. We think trying to squeeze out gains by trading a stock rather than investing can send mixed messages and lowers the accessibility for investors who don’t trade daily. We think it is easier for our readers if our positions are clear and predictable. Very few of our readers have time to trade actively and we want to be a calming force in what can be a turbulent process.
We also take our role seriously in that we disclose our entries and exits in real-time while also being audited by a third-party for full year performance. Below, we illustrate how the I/O Fund works by looking at our current analysis of Roku and the levels we are watching.
Relative Strength
More often than not, the leaders out of a large correction tend to lead in the next leg up. Our system is setup to identify sectors and stocks that exhibit this relative strength to help guide our allocations.
However, there are exceptions. Roku is currently trading under its 50-day moving average, which is hovering around $390. Since the March 5th bottom, Roku has shown weaker relative strength than the NASDAQ100 (NDX). NDX is up ~5% while Roku is down ~5%).
It’s worth noting that Roku is up 1% over the last 3 months, and up 305% over the last year, compared to the NASDAQ100, which is down about 12% over the last 3 months and up about 78% over the last year.
Time frames are important. In fact, the relative strength of the OTT/Ad Tech world has fallen dramatically and is ranked dead last in our screens over the last 4 weeks.
Usually, when we see this level of poor relative strength potentially coming out of a correction, we take note.
However, there is more to this story than a fading trend. Note the ranks and returns of this microsector further out. On a 3-month and 6-month basis, it’s ranked in the top percentile. This includes the recent selloff.
The level of strength is further shown in its YTD returns of around 8%, second only to semiconductors, around 11.5%. Once again, this includes the recent bout of weakness.
What changed was Bill Hwang’s leverage bets in Chinese and American media stocks, which caused a $20 billion forced liquidation of his portfolio. Since then, we have seen a fast to slow unwind of many OTT/Ad-Tech names, which has skewed the relative strength of this microsector.
Prior to the forced unwinding, this microsector was ranked in the top decile of all the tech sectors we track. Because of this, we believe that the opportunity to accumulate specific stocks in this field is unique.
Roku’s Opportunity
Regarding Roku, we outlined the potential 4th wave drawdown and warned our readers of a top forming. On February 11th when Roku was trading around $475, within our forum, we stated
“Note all the sell signals – overbought (check), Demark 9 signal (check), RSI and MACD are showing negative divergence (check). I believe we are coming to the end of a minor degree 3rd wave (pink), which will set up a great buying opportunity.”
We later outlined potential tragets for a bottom on March 1st in one of our premium webinars, by stating “I believe Roku has topped out in its 3rd wave. The 4th wave targets are $335 to $265.”
Again, on March 30th, we reaffirmed our target region by stating “We are square in the 4th wave target box. The $300 level is very strong support. Below that is $275 and then $265. I doubt we tag $265 with the internals where they are.”
Today, we think the evidence supports a bottom in Roku for this correction.
For one, the price hit a wall of support at the $300 region, which is square in the middle of the most probable 4th wave target zone. The CCI, which is a momentum oscillator, tagged the same region we saw at the bottom of the March 2020 low. This is classic uptrend behavior, where we see momentum hit major support or lower while price is higher.
Also, note the positive divergence with RSI, another popular momentum oscillator. RSI is making a lower high while price makes a lower low. The two of these indicators are providing classic bottoming signals.
Learn more about the crucial difference between Netflix and Roku here, and why Beth is confident that Roku’s best years are still ahead. Find out what levels we are watching on NDX to confirm an end to the correction here.
Roku: Levels to Watch
We expect the uptrend to continue to all new highs as long as the $292 low holds. Below $292, and we will look next for a bottom around the $280-$275 region, before the uptrend resumes. We think a test of the 200-day SMA ($265) to be less probable based on how oversold the momentum-based internals are with Roku.
In conclusion, the more probable scenario is that the bottom is in.
Disclaimer: Knox Ridleyand the I/O Fund is currently invested in ROKU. The content in this article is intended to be used for informational purposes only. The author has not received any compensation from any third party or company discussed in this article. The content is the expressed opinions of the author and is intended for educational and research purposes. Any thesis presented is not a guarantee of any particular stock’s future prices, so please factor this risk into your own analysis. It is very important that you do your own analysis before making any investments based on your personal circumstances. The author is not a licensed professional advisor. Please seek counsel form a licensed professional before acting on any analysis expressed in this article, to see if it is appropriate for your personal situation.
