Apple’s Services Growth Flywheel Continues To Strengthen

Posted on November 21, 2023June 30, 2026 by io-fund

This article was originally published on Forbes on Nov 16, 2023,05:19pm ESTForbes Forbes on Nov 16, 2023,05:19pm EST

Apple’s Services segment was one of the brightest spots in a relatively in-line earnings report at the beginning of November, topping an $85 billion run rate as growth jumped back to the high double-digits after a string of single-digit growth. Services demonstrated that its growth flywheel continues to strengthen with multiple outlets of opportunity in sight — from AI, to further growth in the installed base, to price hikes across different Services bundles.

Services Growth Outpaces iPhone, Apple

Since fiscal 2018, Services has become increasingly important to both the top and bottom lines for Apple. The segment has seen its share of revenue rise from under 15% five years ago to 22.2% at the end of September. Since then, Services has seen its annual run rate increase from ~$40 billion to over $85 billion, on track to surpass a $100 billion run rate potentially as early as the second half FY24.

FY21 was a breakout year for Services – the segment recorded greater than 24% YoY growth and generated more than $10 billion in gross profit each quarter, as its gross margin neared 70%. Gross margin has continued to stay above the 70% range, rising as high as 72.6% in Q2 FY22.

Source: I/O Fund

FY23 ending in September saw a full year growth rate of 7.1% YoY for $85.2 billion outpacing both iPhone and company-wide growth, with Q4 being the strongest quarter of the fiscal year with a growth rate of 16.3% YoY. The I/O Fund recently covered Apple’s earnings report more in-depth following fiscal Q4 here.

Since FY18, Apple has grown revenue at a 7.6% CAGR, meanwhile, Apple’s company-wide gross profit has grown at a 10.1% CAGR over the same period with profits partly impacted by Services’ rising contribution and expanding margin.

Compared to Apple, Services is seeing revenue and gross profit grow at much quicker rates – more than 9 percentage points higher for both metrics. Since FY18, Services revenue has grown at a 16.5% CAGR, outpacing Apple’s 7.6% growth rate as well as the iPhone’s 4.0% CAGR, due to the unevenness in revenue in between upgrade cycles – iPhone delivered YoY revenue declines in FY19, FY20, and FY23.

Services’ gross profit has expanded at a 20.1% CAGR, rising around 150% since FY18, from $24.2 billion to $60.3 billion as gross margin has expanded 10 percentage points, from 60.8% to 70.8%. This strong revenue and gross profit growth over the past five years has seen Services gain importance to Apple’s margins and its bottom line.

Source: Apple

In FY18, Services contributed 23.7% of Apple’s gross profit, whereas today, Services contributes 36% of gross profit.

The breakdown looks like this:

As Services’ share of revenue rose from 15% to 22.2%, it helped pull Apple’s gross margin ~580 bp higher in just five years. Product gross margin – iPhone, Mac, iPad, etc. – increased just 210 bp, meaning this expansion in gross margin is primarily coming from Services.

FY21 was a breakout year for Apple’s gross margin, expanding from 38% to more than 42% because of that growth in Services. Apple is guiding for gross margin to expand further in fiscal Q1 next year, to the 45% to 46% range – an expansion of 200 to 300 bp YoY, with Services’ growth rate forecast to be in the high-teens again.

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Services Seeing Multiple Growth Outlets

Services growth has been broad based, with new revenue records across a range of different offerings, and the segment has multiple growth outlets to lever in the future, from growth in paid subscribers, AI, and price hikes.

CEO Tim Cook explained on Apple’s Q4 earnings call that the Services segment “achieved all-time revenue records across App Store, advertising, AppleCare, iCloud, payment services, and video, as well as the September quarter revenue record in Apple Music.” CFO Luca Maestri added that Services “reached all-time revenue records in the Americas, Europe and rest of Asia-Pacific and a September quarter record in Greater China.”

What is driving these record levels across multiple Services offerings and in every geography worldwide is solid growth in active devices and strong growth in paid subscriptions. Paid subscriptions have risen at more than 27% annually over the past five years to 1 billion by the end of FY23.

Source: APPLE

Apple has surpassed 2 billion installed devices, and “continues to grow at a nice pace and establishes a solid foundation for the future expansion of the ecosystem.” Thus, the organic growth flywheel for Services remains soundly intact – growth in installed devices driving growth in paid and transacting accounts at a higher degree.

At the start of FY18, Apple reported that it had an installed active device base of 1.3 billion devices, meaning it had a ratio of about 0.18 paid subscriptions per 1 active device. Since then, installed devices have grown more than +50% to over 2 billion, while paid subscriptions have grown nearly +360% to almost 1.1 billion, or a ratio of about 0.5 paid subscriptions per active device.

Reaching new all-time highs in its installed device base signals further growth lies ahead for Services, especially as the ratio of paid subscriptions per active device continues to rise. Other outlets of growth arise from Apple’s recent price hikes and potential monetization opportunities from AI.

Additional Levers

Apple recently enacted some price hikes for News+, Arcade, and its One bundles, with the hikes ranging from $2/mo to $5/mo. As a whole, the price hikes could generate an additional ~$5 billion in annual revenue with just a 15% attach rate to Apple’s more than 1 billion paid subscriptions — however, the price hikes could incur a small amount of churn, among more price-sensitive consumers.

In terms of AI, Apple is not releasing any details about projects in development, though it is rumored that some of the AI products Apple is working on would improve Siri and Messages’ capabilities, or add features to Keynote, Pages, and Apple Music. Apple’s large language model ‘Apple GPT’ is reportedly under development, but a commercialization route is still undetermined. The next-generation of Apple’s software, iOS 18, macOS 15, and watchOS 11, are poised to bring AI features to Apple’s devices next year, as it works to catch up in the generative AI deployment race against OpenAI and Google.

For any of its AI products, there are three routes that could boost Services revenue – adding AI features for free in an aim to boost engagement across offerings, charging a subscription fee for AI features, or increasing prices of current bundles that incorporate AI. For example, if Apple charged for a stand-alone AI subscription at a $2.99/mo price point, it could rake in ~$10.8 billion in annual revenue at a 15% attach rate to its more than 2 billion active devices; boosting the prices of all of its subscription bundles by $0.99/mo could also add more than $10 billion annually.

In a previous Forbes article “AI Could Be Apple’s Next Chapter,” my firm pointed out that: “although Apple is tight-lipped about the progress of its AI projects, the so-called Apple GPT chatbot is rumored to be more powerful than Open AI’s GPT 3.5 model, according to The Verge. Apple is spending millions of dollars a day training the large language model Ajax on more than 200 billion parameters.”

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iPhone Demand Uncertain, China Risks Remain

Analysts have expressed concern over the holiday launch trajectory of Apple’s new iPhone 15, hinting that supply shortages, lower levels of consumer spending, and shorter wait times suggest weaker demand. The iPhone remains Apple's main source of revenue, and a conservative fiscal Q1 guide from the company along with heightened concerns over iPhone 15 demand add to risks that iPhone revenue growth in the near-term will remain depressed, after growing just +2.6% YoY in Q4.

Other concerns arise from Apple’s concentration in China, in regard to its iPhone supply base. Bank of America warned that Apple’s iPhone “supplier base remains largely in China,” which could “create many headwinds including around production, demand, [and] competition,” given that it is “hard to move all elements out of China.”

Services remains strong and a segment to watch, but we need the iPhone to participate and come in strong too, with a lingering risk to watch around China. Without the iPhone participating, Services is not enough to carry Apple’s stock alone, especially given its current valuation trading at levels hard to sustain.

Source: YCHARTS

Apple is currently trading at a 7.76x P/S ratio, above its 5-year median P/S ratio of 6.59x, with the 8.0x a level that Apple has struggled to hold on to since spiking to it in 2020. Apple is also trading at a nearly 28.8x forward P/E ratio, again another valuation level that it has struggled to hold on to – since late 2021, Apple has generally pulled back to below 24x forward P/E after trading above the 28 range.

Source: YCHARTS

However, another risk to watch is Alphabet’s antitrust trial, as it could have direct implications for Apple in the event of a negative ruling. Alphabet’s multi-billion dollar payments to Apple for Google to be the primary search engine on Safari across Apple’s devices is at the center of the trial, and that payment is rumored to be ~$19 billion this year – a key witness mentioned during the trial that Google is paying Apple 36% of search advertising revenue it generates via Safari. Should the scale of those payments constitute monopolization of the search market, Apple could be set to lose on a lucrative Services revenue stream.

Conclusion

Services is rapidly becoming one of Apple’s most important top-line segments, and arguably is the most important for Apple’s bottom-line, given its outsized role in boosting Apple’s gross margin. Organic growth has been a strong driver of Services’ +16.5% 5-year revenue CAGR and its +20.1% 5-year gross profit CAGR, both of which outpace Apple’s growth rates by more than 9 percentage points.

Should Services continue to grow in the teens for the next five years, such as at a 14% 5-year CAGR through FY28, it would be generating approximately $164 billion in revenue, or slightly more than 30% of Apple’s projected $538.6 billion in revenue. Price hikes, introduction of AI features, or finding ways to increase engagement and boost the ratio of paid subscriptions per active device all support this long-term revenue growth outlook for the segment.

Damien Robbins, Equity Analyst at the I/O Fund, contributed to this article.

The I/O Fund was early to AI with a 45% allocation in 2023. For more in-depth research from Beth, including 15-page+ deep dives on the 10 stock positions the I/O Fund owns, subscribe here.

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.

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Netflix: Cash is King and Pivot is on Track

Posted on October 19, 2023June 30, 2026 by io-fund

Five quarters ago, we took a chance on entering Netflix in 2022 based on two things:

1. The upcoming pivot to monetize through ads and by cutting off password sharing. In the June quarter of 2022, Netflix reported negative net additions QoQ. This quarter, Netflix reported some of the best growth in recent quarters. Notably, ads are not contributing meaningfully. Password sharing is helping the company drive growth in paid memberships both YoY and QoQ following the December quarter.

Per management: “The cancel reaction continues to be low, exceeding our expectations, and borrower households converting into full paying memberships are demonstrating healthy retention. As a result, we’re revenue positive in every region when accounting for additional spin off accounts and extra members, churn and changes to our plan mix.”

2. Improved cash profile from negative (-$3.3B) in 2019 to a positive $1.6B in 2022. We had noted that management stated there would be substantial FCF growth in 2023. At the time, we had hoped for $3B to $4B in 2023. By raising FCF guidance every quarter this year, FCF will now come in at $6.5B. This is a phenomenal beat, although roughly $1 billion is from the Writer’s Strike. When adjusting for this, FCF is at $5.5 billion, which more realistically sets expectations for 2024 when content spend will be higher than 2023.

The weak spot in the report was average revenue per member, which declined (1%). Ideally, this improves with the price hikes the company announced today. This is reflected by a net paid addition beat that does not result in a revenue beat. With management guiding for similar net paid adds as Q3 (implying 9M) plus higher prices, the market is rewarding the stock because it’s assumed ARM will be higher next quarter. Netflix investors should continue to monitor lower ARM countries as time goes on as outsized growth here can potentially weigh on revenue growth. Last quarter, ARM was (-3%) and (-1%) on a CC basis.

Revenue and EPS:

Netflix reported revenue of $8.5 billion in line with management guidance and analyst consensus. This represents growth of 7.8% and 8% on a constant currency basis (CC). This is an acceleration QoQ from the 2.7% growth and 6% on CC basis last quarter. However, this is not an acceleration from the year ago quarter on a CC basis, which grew 13%.
Next quarter, Netflix guided in line for revenue of $8.7 billion for growth of 11% and 12% on CC basis. This will be an acceleration both QoQ (to be expected due to seasonality) and year-over-year with 10% growth on a CC basis in the year ago quarter.
Overall, Netflix’s revenue growth is expected to trend upward over the next few quarters.
The analyst consensus for adjusted EPS was $3.48 compared to $3.73 reported.

Operating Margin: A Bit of Confusion Following CFO Commentary Last Month

Analysts were expressing concerns going into this call about the FY2024 operating margin following a Bank of America conference when Spencer Neumann, CFO of the company, said:

“So I don't think given our scale now that we're at roughly 20% operating margins, I don't think it's really prudent for us to keep growing at 3 percentage points of margin per year. I think that would probably constrain the business too much on the growth opportunity. So, we'll grow margins more gradually. At some point, there's probably some peak margin where it's a good balance between peak margin and growth potential of the business. I just don't think we're anywhere near that yet. So we're going to gradually go into it.”I don't think it's really prudent for us to keep growing at 3 percentage points of margin per year. I think that would probably constrain the business too much on the growth opportunity. So, we'll grow margins more gradually. At some point, there's probably some peak margin where it's a good balance between peak margin and growth potential of the business. I just don't think we're anywhere near that yet. So we're going to gradually go into it.”

This caused analysts to scramble and lower their price targets as some had a 279 bps estimate for next quarter.

For example, published on September 28th: “JPMorgan lowered the firm's price target on Netflix to $455 from $505 and keeps an Overweight rating on the shares ahead of the Q3 report. The firm's overall view on Netflix shares remains positive, but it lowered estimates to reflect recent comments from management around margin expansion. Investor conversations suggest increased concerns that paid sharing is less impactful than expected and providing less lift in Q4, while 2024 margin expansion could be less robust than anticipated, the analyst tells investors in a research note.”

Here's another one from September 22nd:

“Oppenheimer lowered the firm's price target on Netflix to $470 from $515 and keeps an Outperform rating on the shares following the CFO's comments at a conference. The CFO said he was "not expecting future operating leverage of 300bps" going forward, and while the comments are likely not intended to be guidance, the firm took notice, given its prior view of 279bps improvement, the analyst tells investors in a research note.

There are quite a few like this. The interesting part is that Netflix actually guided operating margin for FY2024 growth of 200 bps to 300 bps, or 250 bps at the midpoint. Therefore, the comments may have been taken out of context to mean future years (?) as the guide was strong all things considered.

Gross margin of 42.3% was in line
Operating margin of 22.4% was in line. Management stated the FY2023 operating margin would be 20%, which was at the high end of previous guidance of 18% to 20%.
Net profit of $1.68 billion was up 19.6%
For full year 2024, management stated they are expecting full year operating margin of 22% to 23%.

Cash:

Netflix repurchased $2.5B in shares and increased the buyback authorization by $10B.

The company’s cash flow margins are a highlight of the report. Operating cash flow of $1.992 billion represents a cash flow margin of 23.3%. Free cash flow of $1.888B represents a FCF margin of 22.1%. This is up from a FCF margin of 6% in the year ago quarter. This is outsized due to the writer’s strike.

Overall, Netflix has substantial long-term debt and always will. We’ve covered this extensively in the past as their business model requires high content spend. The gross debt is $14 billion and the net debt is $6.5 billion.

Per management: “expect FCF of $6.5B up from $5B prior forecast. The company repurchased $2.5B shares in Q3 and increased buyback authorization by $10B. As a result, we expect 2023 cash content spend of around $13B and, assuming the SAG-AFTRA strike is resolved in the near future, we are currently expecting cash content spend of up to ~$17B in 2024.

As we said last quarter, the strikes will create some lumpiness in FCF over the 2023/2024 period, but we still plan to deliver very substantial positive FCF in 2024.”

Key Metrics:

Netflix reported 8.7M net paid adds for a total of 247.2 million paid memberships. This is the highest number of paid net adds in recent quarters. Analyst consensus was between 6.5M and 6.9M. Per management, this was due to: “the roll out of paid sharing, strong, steady programming and the ongoing expansion of streaming globally"

Across the regions, ARM in APAC had the biggest decline at (-9%). The United States region technically declined (Netflix reporting this as 0%) from $16.37 ARM a year ago to $16.29 ARM in the most recent quarter. All regions added paid net additions.

Across all regions, ARM was down (-1%). As stated, look for ARM to resume growth following the price hikes that were announced today.

Management stated that “ads plan membership is up 70% QoQ.” This is not meaningfully contributing to revenue. According to the Investor Letter: “It’s been less than a year since launch. It takes time to build a new business from scratch, which is why we have said ad revenue would not be material to our business in 2023.

Regarding engagement, Netflix had the most watched Series for 37 out of the first 38 weeks of the year. Share of screen time was 8% and second only to YouTube.

Earnings Call:

This was an important statement in terms of Netflix’s expectations for future revenue growth based on cutting off password sharing. I’m liking the word “incremental” here:

“So we're going to continue the rollout for the next couple of quarters. I think folks are trying to figure out how much juice is left there. And I would say we anticipate that we will have incremental acquisition, incremental adds for the next several quarters. We've seen that in the last couple of quarters. I think also worth noting that, that was on top of also very healthy organic, meaning not driven by paid sharing growth. So we anticipate seeing that for the next several quarters to come.”

There was a lot of discussion on the ads business, but the main takeaway is that the ads business has not taken off yet. However, management seems to think by 2024 it will begin to affect net paid adds and ARM:

“So I would say just generally, when we think about 2024 and beyond, think about it as our revenue growth profile in general. And we talked about this recently. We expect a more balanced mix of membership and ARM growth in 2024 and beyond 2024. So just looking at 2024 specifically, as Ted talked about, we expect to have a great slate to drive the business forward. And we expect to continue to do things like add extra members, grow our advertising revenue, as Greg discussed.”

Conclusion:

Netflix is exactly where we hoped it would be in terms of its product story and fundamentals. There has been ongoing uncertainty around whether the company would do well with the pivot. The writer’s strike and new management team has added to this uncertainty. This quarter helped provide the market with more visibility that the juggernaut is right on track. The only blemish in the report is ARM, which is being addressed in the upcoming pricing increases. We are very early in the earnings season, yet as more companies report, I think Netflix will stand out as company handling a challenging macro environment with ease.

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Netflix: Cash is King and Pivot is on Track

Posted on October 19, 2023June 30, 2026 by io-fund

Five quarters ago, we took a chance on entering Netflix in 2022 based on two things:

Revenue and EPS:

Netflix reported revenue of $8.5 billion in line with management guidance and analyst consensus. This represents growth of 7.8% and 8% on a constant currency basis (CC). This is an acceleration QoQ from the 2.7% growth and 6% on CC basis last quarter. However, this is not an acceleration from the year ago quarter on a CC basis, which grew 13%.
Next quarter, Netflix guided in line for revenue of $8.7 billion for growth of 11% and 12% on CC basis. This will be an acceleration both QoQ (to be expected due to seasonality) and year-over-year with 10% growth on a CC basis in the year ago quarter.
Overall, Netflix’s revenue growth is expected to trend upward over the next few quarters.
The analyst consensus for adjusted EPS was $3.48 compared to $3.73 reported.

Operating Margin: A Bit of Confusion Following CFO Commentary Last Month

Analysts were expressing concerns going into this call about the FY2024 operating margin following a Bank of America conference when Spencer Neumann, CFO of the company, said:

This caused analysts to scramble and lower their price targets as some had a 279 bps estimate for next quarter.

Here's another one from September 22nd:

Gross margin of 42.3% was in line
Operating margin of 22.4% was in line. Management stated the FY2023 operating margin would be 20%, which was at the high end of previous guidance of 18% to 20%.
Net profit of $1.68 billion was up 19.6%
For full year 2024, management stated they are expecting full year operating margin of 22% to 23%.

Cash:

Netflix repurchased $2.5B in shares and increased the buyback authorization by $10B.

As we said last quarter, the strikes will create some lumpiness in FCF over the 2023/2024 period, but we still plan to deliver very substantial positive FCF in 2024.”

Key Metrics:

Across all regions, ARM was down (-1%). As stated, look for ARM to resume growth following the price hikes that were announced today.

Regarding engagement, Netflix had the most watched Series for 37 out of the first 38 weeks of the year. Share of screen time was 8% and second only to YouTube.

Earnings Call:

This was an important statement in terms of Netflix’s expectations for future revenue growth based on cutting off password sharing. I’m liking the word “incremental” here:

Conclusion:

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Netflix Q2 2023 Earnings: UCAN Region Flat on Revenue

Posted on July 20, 2023June 30, 2026 by io-fund

Netflix’s report had some puts and takes.

Positives:

EPS was a beat at $3.29 versus $2.86 expected. The previous free cash flow guide for FY2023 was at $3.5 billion, and the full year guide is now raised to $5 billion this year. The company beat on paid net adds at 5.9 million compared to 2.1 million expected. Notably, the beat on net adds is coming from paid sharing, to where you can pay a lower fee to be added to someone’s account. The beat is not coming from the ad tier.

There was a marginal miss on revenue at $8.18 billion compared to $8.29 billion expected. There was also a marginal miss on forward revenue at $8.52 billion management guidance versus $8.68 billion expected. These things may seem insignificant, but most tech stocks are priced to perfection right now.

The question is why did Netflix have such a big beat on net adds but not on revenue?

Negatives:

This is a blemish because in the past, the region grew 10% in revenue with similar net paid adds (reference Dec 2022 quarter), or there were no new net adds and still grew 9% in revenue (reference September 2022 quarter). Notably, even when Netflix lost 1.3 million subscribers, the company grew UCAN by 10% YoY on CC Basis. Therefore, it is unusual that Netflix did not grow revenue YoY in UCAN region, especially given the net adds.

Almost half of Netflix’s revenue comes from UCAN and so it’s watched closely. According to management, the UCAN region had benefited from increased pricing and is now only reflecting paid sharing plans. The UCAN region resulted in overall ARM being down 1%.

Today, separate from the earnings report, Netflix removed the basic, ad-free option for new subscribers in the United States and United Kingdom. New subscribers will have to pay $6.99 with ads or $15.49 without ads, eliminating the $9.99 tier.

On a side note, the ads ARM is expected to be $8.50, per management comments in the call.

Margins:

Margins were strong. Gross margin was flat yet operating margin was a beat by 330 basis points for an operating margin of 22.3% and operating income of $1.827 billion. Net margin also surpassed expectations by 260 basis points, which flowed to the beat on EPS.

Cash:

As stated, cash was quite strong at $1.44 billion in the quarter, up from $103 million a year ago. Management raised guidance from $3.5 billion in FCF for the fiscal year to $5 billion in the current fiscal year.

Earnings Call:

As stated, the primary blemish is related to UCAN. In the call, management emphasized overall revenue will accelerate yet could have been more clear about UCAN specifically.

This was stated at one point regarding ARM being down next quarter, as well: “But if you think about the drivers of average revenue per member, starting with the revenue drivers that we spoke about a moment ago, you can see our FX neutral, ARM is — it was down 1%, FX neutral in Q2 and we expect similar in Q3, flat to slightly down. That's mostly due to the limited price adjustments we mentioned over the past year in our big revenue markets in advance of rolling out paid sharing.”

Jessica Reif Ehrlich:

“Well, maybe you can help us think through like in UCAN, how much of the ARM growth is a function of add-on members to existing accounts versus new subs signing up to higher priced plans. And it sounds like from your letter that ARM will accelerate in the second half as you get further along in password sharing. Is that correct?”

Spencer Neumann:

“Yeah. Maybe just broadly thinking about our kind of revenue in Q2 and going forward. Jessica, the key is that we delivered revenue in line in Q2 with our expectations and we're on track to accelerate that revenue in Q3 and further accelerated in Q4. That's really our primary objective around revenue acceleration and we're set to deliver on it. But if we step back on thinking about our revenue growth and components overall or within a given region, it's driven by a combination of pricing, volume and new revenue streams like ads.

So if we think about each one of those, so we're now more than a year out from any price adjustments in our big revenue countries. We largely paused them during paid sharing rollout and so that's to be expected. For ads, that new revenue stream, we've expected a gradual revenue build and so that's not expected to be a big contributor this year. So continues to be on target. So most of our revenue growth this year is from growth in volume through new paid memberships and that's largely driven by our paid sharing rollout.”

The Hollywood strike is also a concern although management was bit vague about the implications other than saying: “These strikes, this strike is not an outcome that we wanted” and did not answer the question directly as to how much content they have in the pipeline before they run out. My takeaway was that Netflix’s stock will be impacted the longer the strike continues.

Conclusion:

Having a large beat on paid net adds but not translating that to revenue is not ideal. The company is being clear about revenue acceleration into the back half of the year, which means investors are being asked to be patient. We will likely be patient to some extent, but probably not at this allocation and with these gains. Overall, I imagine we will trim on this report. The stock has done quite well and we’d like to keep some of those gains given the weaker-than-expected quarterly report.

Netflix Q2 2023 Earnings: UCAN Region Flat on Revenue

Posted on July 20, 2023June 30, 2026 by io-fund

Netflix’s report had some puts and takes.

Positives:

The question is why did Netflix have such a big beat on net adds but not on revenue?

Negatives:

On a side note, the ads ARM is expected to be $8.50, per management comments in the call.

Margins:

Cash:

Earnings Call:

As stated, the primary blemish is related to UCAN. In the call, management emphasized overall revenue will accelerate yet could have been more clear about UCAN specifically.

Jessica Reif Ehrlich:

Spencer Neumann:

Conclusion:

Apple Bets On The Emerging Markets Growth Story

Posted on June 5, 2023June 30, 2026 by io-fund

This article was originally published on Forbes on Jun 1, 2023,08:15am EDTForbes Forbes on Jun 1, 2023,08:15am EDT

The smartphone market continues to be hit hard in q1, with prices down 20% and shipments down 13%, according to Canalys. Despite double digit decline across the industry, Apple delivered marginal growth on its iPhone sales at +1.5%. According to Counterpoint Research, Apple grew smartphone shipments by 1 million year-over-year from 59 million in Q1 2022 to 58 million in Q1 2023. The decline of (1.7%) was better than the (14%) decline for the global smartphone market.

Source: BETH KINDIG

According to Apple’s management, the reason the company was able to overcome smartphone weakness was due to sales in the emerging markets. The company’s CFO, Luca Maestri, said in the earnings call, “We set March quarter records in several developed and emerging markets with India, Indonesia, Turkey and the UAE doubling on a year-over-year basis.”We set March quarter records in several developed and emerging markets with India, Indonesia, Turkey and the UAE doubling on a year-over-year basis.”

Within the emerging markets, India is a primary focus for Apple due to a growing middle class. According to a survey from a non-profit, the middle-class population has grown from 14% in 2004-05 to 31% in 2020-21. Tim Cook also points to the fact that the country is at a tipping point. “There are a lot of people coming into the middle class, and I really feel that India is at a tipping point, and it's great to be there.”There are a lot of people coming into the middle class, and I really feel that India is at a tipping point, and it's great to be there.”

Although Apple does not break down India sales figures, Bloomberg News reported that sales grew by 46% YoY to about $6 billion for the trailing twelve months ending March 2023. According to a Wedbush analyst, “Apple is now aggressively looking at India from both a production and retail expansion over the coming years that the firm believes will be a strategic poker move for Cupertino that could ramp annual revenue to $20 billion by 2025 in India.”

Tim Cook recently visited India in April and opened two company-owned retail stores. Apple was the second biggest revenue generating brand in India in 2022, second only to Samsung as it gained 18% of the total value of smartphone shipments, according to research firm Counterpoint.

The company also plans to make India a manufacturing hub and this move is seen as the company’s efforts to rely less on China. JP Morgan mentioned in its research note last year that the company plans to produce 25% of all iPhones from India by 2025. However, it could take a few more years to reach the 25% level. According to Bloomberg News, the company now produces 7% of total iPhones from India and this is up from 1% in 2021.

Apple supplier Foxconn announced recently that the company plans to invest $500 million to set up a manufacturing plant in India. It had also announced in March that it received approval from another state in India for a $968 million investment. Similarly, Foxconn has plans to expand its existing manufacturing plants in India.

There are 2 billion Apple devices active in the world and there are 659 million smartphone users in India, compared to 975 million in China and 276 million in the United States. With India being second place, it makes sense that Tim Cook is focused here.

Source: Statista

According to Morgan Stanley analyst Erik Woodring, “The firm's 2023 revenue and EPS forecast increased by 1% and 3%, respectively, post-earnings and while the firm calls out iPhone 15 and an AR/VR headset as the next catalysts, it adds "don't sleep" on the emerging markets and India story at Apple.”

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Apple’s Brand Needs a Catalyst

Warren Buffet was recently asked why he is invested in Apple and his reply was “If you’re an Apple user and somebody offers you $10,000, but the only proviso is they’ll take away your iPhone and you’ll never be able to buy another, you’re not going to take it. If they tell you if you buy another Ford car, they’ll give you $10,000 not to do that, you’ll take the $10,000 and you’ll buy a Chevy instead.”

Not surprisingly, Apple is one of the world’s most valuable brands, rivaled only by Amazon and Google.

Source: I/O FUND

Despite this strong brand, the next chapter for Apple has been slow to materialize. As seen below, wearables have not become the “next big thing” for Apple with $8 billion or so in revenue per quarter. Emerging markets are promising, yet at the $20 billion per year or $5 billion per quarter, Apple will struggle to move the needle for some time by relying on this strategy alone.

Earlier this month, we published an article “Apple’s Stock in Focus: More Profitable Than Banks” where we stated:

“Investors looking for the “next big thing” will point toward companies like Stripe, Sofi or Square as the leading fintech stocks. Meanwhile, the next big thing to disrupt the financial sector may be sitting in plain sight. Apple grew its cash trove through legendary design and hardware, yet how Apple chooses to leverage its enormous reserve of cash may be what writes the next chapter for the world’s most valuable company.”

Services remain a long-term opportunity for the company to monetize its installed base of over 2 billion active devices. Apple recently launched a new high-yield savings account that offers a 4.15% interest rate, which is 10 times higher than the United States national average and 415 times higher than what Chase or Bank of America offers at 0.01%. Apple is also lending from its balance sheet for the first time ever through Apple Pay’s Buy Now and Pay Later product.

To illustrate how effective Apple’s move into finance tech has become, the cornerstone product, Apple Pay, currently has 75 percent adoption among iPhone users. This is up from 10% in 2016. In addition to taking on banks, Apple is also competing with Mastercard and Visa with features that allow merchants to use iPhones and iPads to send and receive payments. The long-term goal is to replace wallets with iPhones.

Spotlight on Earnings

For some time now, Apple has been a value stock. We discussed this when we stated:

“While comparing to other popular value stocks like Walmart, Apple is trading at a slightly higher forward P/E ratio of 23 compared to Walmart’s 19. However, the company’s net profit margin of 25.71% is very good compared to Walmart’s 1.45%.

Similarly, Apple has an excellent free cash flow margin of 26.37% compared to Walmart's negative free cash flow margin of -5.15%. This helps illustrate why Apple’s stock has held up well as investors are able to participate in the most cash efficient company of all time while also participating in the company’s future innovation cycle.”

The most recent earnings results continue to prove that Apple’s management team is strong on efficiency. Despite revenue declining by (2.5%) YoY to $94.84B, the gross margin improved from 43.8% to 44.3% in the most recent quarter, up 50 basis points due to cost savings and a favorable mix from Services. The free cash flow margin remained solid at 27% compared to 26.4% in the same period last year. The board also authorized an additional $90 billion share repurchase and increased the quarterly dividend by 4% to $0.24 per share.

Source: COMPANY IR

Operating income declined by (5.5%) and net income declined by (3.4%) YoY to $24.2 billion. EPS of $1.52 remained unchanged from the same period last year, and notably, the company beat EPS estimates by 6.4%.

As stated, iPhone sales were up +1.5% to $51.3 billion. Mac revenue declined by (31%) YoY to $7.2 billion. This was due to a strong comp with M1 MacBooks sales from last year and a weaker consumer. iPad declined (13%) YoY to $6.7 billion. Wearables declined (0.6%) to $8.8 billion.

Services grew 5.5% YoY to $20.9 billion.

Paid subscriptions of 975 million, was up 18.2% YoY. This segment is important as there is a higher gross margin of 71% compared to 36.7% for products.

Management’s directional insights for the June quarter were soft with foreign exchange negatively impacting growth by about 4%. The company’s CFO, Luca Maestri, said in the earnings call, “We expect our June quarter year-over-year revenue performance to be similar to the March quarter, assuming that the macroeconomic outlook does not worsen from what we are projecting today for the current quarter. Foreign exchange will continue to be a headwind and we expect a negative year-over-year impact of nearly four percentage points.”

Analysts expect revenue to decline by (1.1%) YoY to $82.03 billion.

Where Can Apple Stock Go from Here?

There are two scenarios we are tracking for Apple based on the current price information:

The blue count suggests that we are in a long and drawn-out correction that will ultimately be targeting new lows. If Apple stays below $181.50 and then breaks below $150.50, the odds that this scenario is playing out will become very high. If this plays out, we will look towards the blue target box for a major low.

The red count suggests that the January low for Apple was a major one. This will put us in the final push in the large uptrend that began in 2009. If Apple can break above $181.50, we can see a final push to the upper red target box between $192 – $210.

Source: I/O Fund

Apple is currently under the major resistance zone between $176.25 – $181.50. Based on the relative weakness in most markets right now – small caps, industrials, materials, financials, transportation, the Dow Jones, as well as many global markets – we are expecting volatility to return sometime in early June. If Apple fails to punch through the $181.50 resistance before the market pulls back, it will need to hold the $160 – $150.50 range in order to allow for this final swing into the red target zone above. Below $150.50 and the top will be in for Apple, as the odds will greatly increase that we will be testing Apple’s January lows.

Conclusion:

My firm does not own Apple at the moment, yet given its enormous brand value and high install base, it’s a company we track closely. In addition, the company’s strong financials will only become more attractive in the event of a recession. For our purposes, my firm would want to see Services materialize as a leading Fintech play, and we would want to wait for the price action outlined above to play out before buying this stock.

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 does not own shares in AAPL at the time of writing but may own other stocks pictured in the charts.

Royston Roche, I/O Fund Analyst, contributed to this article.

Apple’s Stock In Focus: More Profitable Than Banks

Posted on May 4, 2023June 30, 2026 by io-fund

This article was originally published on Forbes on May 1, 2023,10:07pm EDTForbes Forbes on May 1, 2023,10:07pm EDT

Investors looking for the “next big thing” will point toward companies like Stripe, Sofi or Square as the leading fintech stocks. Meanwhile, the next big thing to disrupt the financial sector may be sitting in plain sight. Apple grew its cash trove through legendary design and hardware, yet how Apple chooses to leverage its enormous reserve of cash may be what writes the next chapter for the world’s most valuable company.

The markets have clearly shifted from favoring top line growth to emphasizing bottom line strength. This reminder is echoed across every industry, but none more so than the finance industry where regional banks are defaulting due to high bond rates and depositor withdrawals.

It’s easy to dismiss the financial sector in today’s tech focused market. After all, financials only account for 11% of the total market cap of the S&P 500, with 3 sectors ahead of it. However, all companies depend on loans, and when banks get scared, the credit window shuts, which tends to lead to outsized bankruptcies. Simply put, banks cause the worst kinds of recessions. We detailed this more here.

Today, the tech industry has disrupted nearly every industry in its path from energy, to commerce, to automotive, to entertainment. Perhaps now is the time that tech will finally disrupt the banking sector.

Apple Is More Profitable Than Banks

JP Morgan has over $1.4 trillion on its balance sheet compared to Apple’s $165 billion. However, Apple is more profitable with $99 billion in profit last year, which is higher than JP Morgan and Citi combined. What Apple has to boot is access to 1.2 billion iPhone users. Therefore Apple may not have as much cash as a bank, but it’s fundamentally a more investable business model.

For stock investors, Apple’s large cash reserves are certainly not news as the company has more cash than any other tech stock. What’s news is that the FED is aggressively draining liquidity from the system as a means to fight inflation, as shown in the chart below, that compares the trends in liquidity to the S&P 500.

Source: I/O FUND

There has been a long-standing relationship to liquidity and asset prices, and until we can see a new liquidity cycle start, companies with cash will have better leverage over those that don’t. You can also expect volatility in the markets to remain high until there’s a new liquidity cycle, which we covered when we discussed where we hold cash.

The longer this plays out, the more ways Apple can leverage its $165 billion in cash as consumers will seek better financing terms, higher yields and credit lines will also increase.

For example, Apple recently launched a new high-yield savings account that offers a 4.15% interest rate, which is 10 times higher than the United States national average and 415 times higher than what Chase or Bank of America offers at 0.01%. Apple is also lending from its balance sheet for the first time ever through Apple Pay’s Buy Now and Pay Later product.

Apple has the best operating margin among the FAANG stocks at 30.7%. Net profit last quarter was $30 billion with free cash flow of also $30 billion.

Source: I/O FUND

Apple is not immune to the effects felt across corporate bonds and mortgage securities. According to CNBC, the company has $13 billion in unrealized losses. These losses are not reported as long as Apple plans to hold to maturity, and as long as the bond issuers are solvent enough to repay the debt. Also, a loss of $13 billion is not detrimental to Apple, as the company generates $100 billion in free cash flow per year. Notably, the company used to have $250 billion in cash reserves before increasing buybacks in 2017.

Apple has debt of $111 billion for a net cash balance of $54 billion. The company paid $3.8 billion in dividends and equivalents and repurchased shares worth $19.5 billion.

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What to Watch for in Q1 Earnings

Apple is not a growth stock. The company is known for strong margins, outsized cash flows, and stable balance sheet. The company’s revenue has been partly negatively impacted from the adverse FX movements. Analysts expect revenue to decline by (4.6%) YoY to $92.81 billion yet the company’s revenue is expected to grow after the June quarter.

Source: SEEKING ALPHA

On a fiscal year basis, Apple is expected to report a rebound next fiscal year:

Source: SEEKING ALPHA

Apple has the highest operating margins among the FAANG stocks. For EPS, Apple is expected to report the following:

Source: YCHARTS

Apple’s main segments are iPhones, Macs, iPads, Wearables and Services. Of these, the Mac segment is dragging on Apple’s results. Last quarter, Mac sales declined by (29%) YoY to $7.7 billion. Management expects revenue to decline double digits due to challenging comparable with the M1 Mac Books from last year and a weaker consumer.

According to IDC, there was a YoY decline of (29%) in the shipments of traditional PCs in Q1 2023 due to weaker demand and excess inventory. The report from IDC suggests that Macs declined by (40%) in Q1 2023.

iPhone sales in the December quarter declined by (8%) YoY to $65.8 billion yet were flat excluding foreign exchange rates. Management expects revenue to accelerate in the March quarter when compared to the Dec quarter, per the earnings call: “For iPhone, we expect our March quarter year-over-year revenue performance to accelerate relative to the December quarter year-over-year revenue performance.”

According to the research firm Canalys, the global smartphone market declined by (13%) YoY in Q1 2023. The report from Canalys states that Apple gained 3% in global market share from 18% to 21% driven by the demand for iPhone 14 Pro series. Samsung was the only leading vendor to report QoQ growth and also regained the #1 position at 22% market share.

The Services segment is the second largest segment after iPhone. This is where payment services and loan products will show up. Many investors see this as the long-term opportunity as Apple is monetizing it’s installed base of over 2 billion active devices. The installed base grew by 8% YoY. Services revenue grew 6% YoY to $20.8 billion and grew double digits excluding foreign exchange rates.

The company has more than 935 million paid subscriptions, up 19% YoY. Per CFO, Luca Maestri, The growth is coming from every major product category and geographic segment, with strong double-digit increases in emerging markets such as Brazil, Mexico, India, Indonesia, Thailand and Vietnam.”strong double-digit increases in emerging markets such as Brazil, Mexico, India, Indonesia, Thailand and Vietnam.”

Big Tech is Propping up the Nasdaq

In the early phase of a bull market, we tend to see expansive buying amongst most sectors and markets, with a relative focus in your economically sensitive sectors like small caps and high beta names. This is simply not the case right now. In fact, what we are seeing is a handful of big tech names propping up the markets. Meanwhile, underneath this, economically sensitive stocks are getting aggressively sold while Big Tech props up the market.

Source: I/O FUND

Furthermore, the percentage of Microsoft and Apple’s combined weighting in the S&P 500 has never been higher. The S&P 500 weighting is according to market cap, which is price times float. The longer buying happens in these two names, accompanied with selling in other areas of the index, the percentage weighting becomes stretched to unhealthy extremes. This is not characteristic of a burgeoning bull market; instead, it is the type of behavior we see at market tops.

Regarding Apple’s price chart, we believe that the bounce off the October 13th low in 2022 is starting to top out.

I/O FUND

We have been talking about the $169-$170 price target for many months in our premium service. Now that we are here, you can see how the market is trying to push higher on weaker volume and weaker momentum. We could see a push to the $175 region in this final push higher, but soon, AAPL will have to correct. If the structure of this correction is a 5 wave decline, then we will be targeting new lows. On the other hand, if this pullback is a 3 wave move, we could see a move back to the $145 region only, before a fresh attempt higher is made.

Note on Valuation:

Apple is trading at a premium with a current PE ratio of 28. The stock does not tend to hold well at a PE ratio of 30.

Source: I/O FUND

The forward PE Ratio of 28 is also stretched and does not hold well at this level historically.

Source: I/O FUND

Conclusion:

Apple is the most likely candidate to disrupt the financial sector. The company’s reach of 2 billion devices has assisted its slow roll-out of payment services with 75% of iPhone users opting into Apple Pay. One can only imagine the potential success Apple may have in leveraging its cash for higher yields during a time when banks are weak in reputation and balance sheets.

In the upcoming earnings report, expect weakness in Macs to overshadow the other segments. iPhones are expected to be flat yet the Services segment is where fintech growth will show up. Overall, this is unlikely to be a standout quarter for Apple on the top line, so look for surprises on the bottom line to drive the stock.

We have Buy levels we are targeting for Apple, which we share with our premium research members each week as the stock progresses. We believe our target buy level will set us up for gains in Apple’s stock when the next bull cycle begins. We provide in depth macro and individual stock analysis so that readers can better understand why we buy/sell. In this market, we frequently take gains.

We also issue real-time trade alerts when we enter and exit stocks. YTD, our firm has held the two top performing assets in the tech industry – Nvidia and Bitcoin — at high allocations. We also issued a buy alert with NVDA last year at $108 and with Bitcoin in the $16,000 region, based on the type of analysis we provide. You can learn more here including information on our next webinar, this Thursday at 4:30 pm Eastern, where we review our positions live.

Portfolio Manager Knox Ridley and Equity Analyst Royston Roche contributed to this article.

Financials:

Netflix missed on revenue and was inline on EPS. FX headwinds create mixed reactions to this particular earnings report, and I suspect the strong cash flow also helped price after hours. Last quarter, a large EPS miss was reported whereas it was due to a FX adjustment.

This quarter, revenue was $8.162 billion or $8.5 billion on a constant currency basis compared to $8.18 billion estimated. This is widely reported as a miss, but on the other hand, the market has been forgiving of FX headwinds with other companies.

The guide was lower than expected at $8.24 billion compared to $8.48 billion expected. The company is pushing out its expectations for the new ad tier to drive top line growth in Q3 whereas the previous expectation is that this would start to show up in Q2. Password sharing will be “broadly” rolled out including in the United States in Q2.

EPS of $2.88 was in line. EPS for next quarter is a miss at $3.06 EPS expected versus $2.84 EPS guided.

The gross margin is 400 bps lower this year at 41.20% with flat gross profit of $3.35 billion compared to $3.5 billion last year. The operating margin of 21% was also lower compared to last year’s 25% OPM yet this met management’s guide for an operating margin of 18% to 20%. Notably, management had stated last quarter that “operating margin to be down YoY due to timing of content spend.” Similar to operating margin, net margin and adjusted EBITDA were lower but within expectations.

In the comments on the forum, you can read from forum members on why margins are the most important line item for Netflix moving forward.

Netflix exceeded on free cash flow at $2.1 billion compared to $3 billion for the full year last year. The company is raising full year guidance on free cash flow to $3.5 billion. The free cash flow margin is more than double from last year at 25.9% compared to 10.19% in the year ago quarter.

Gross debt is still high at $14.5 billion, which is inherent to the business model. However, net debt is improving at 1.1X compared to 1.3X last quarter with net debt of $6.7 billion compared to $8.37 billion last quarter.

Netflix still trails other FAANGs on its investment rating, yet it’s notable the company has seen an upgrade from Moody’s from junk to investment grade. Netflix has been the black sheep of the FAANGs in this regard, however, a large part of our thesis is based on the company’s change in profile in terms of bottom-line strength.

On another positive note, Moody’s stated the following regarding Netflix’s ad tier: “Moody’s anticipates that growth in subscribers from the recently launched ad supported service will be gradual but steady and provide a strong long-term opportunity for revenue growth.”

Key Metrics & Additional Notes:

Password Sharing & Geographic Regions:

Global paid adds of 1.75M came in slightly shy of analyst estimates of 1.8M.

For password sharing, Latin America provides some clues as to how a broader rollout will perform. According to management there was a cancel reaction which later eased. The region reported a loss of net adds of (0.4M) compared to net adds of 1.76M in Latin American last quarter, yet the revenue was up 7% YoY (+13% on constant currency basis).

The company stated that other regions, such as Canada, were “directionally consistent with what we saw in Latin America.”

There was a similar pattern in the United States Canada (UCAN) region where there was low net adds yet higher revenue growth. The region reported 0.1 net additions with revenue up 8% YoY.

In the year ago quarter, these regions were flat or reported a decline. There can also be churn coming out of Q4 for Netflix since that quarter has high net adds.

Another observation is that LatAm and UCAN both had expanding Arm, or average revenue per membership, whereas the other two regions saw a lower Arm. This could be encouraging in terms of a broader rollout on password sharing driving more top line growth in the second half of the year.

UCAN up +9% from $14.91 to $16.18
LatAm up +3% from $8.37 to $8.60
EMEA down (6%) at $10.89 this quarter compared to $11.56 in the year ago quarter
APAC down (13%) at $8.03 this quarter compared to $9.21 a year ago

Notably, average paid membership increased in APAC, which were up 17%. This is clearly a large region but there’s been some attention on India specifically where Netflix has lowered prices. This would make sense to where net adds increased but ARM decreased.

Ad Tier:

Upfront season is coming, which means Netflix will likely have to state the company’s expected scale for the ad tier come Q3/Q4. Right now, the company is not guiding for this but analysts believe it will be in the 13M range.

We covered this in our Essentials Pre-ER write up. Per Forbes/Bloomberg: “After a slow start Netflix ad tier has been gaining traction with U.S. subscribers. After analyzing their internal data, BloombergBloomberg reported in its first two months, Netflix had one million active users. Before its launch, Netflix had projected 1.1 million by year end 2022 increasing to 13.3 million by the third quarter 2023. Industry analysts project Netflix could eventually wind up with 30 million U.S. subscribers on its ad supported tier. The U.S. is one of the 12 markets where Netflix is now selling ads. At its most recent earnings report Netflix had 74 million total U.S. subscribers with 231 million worldwide.”

The company continues to believe the ad tier will be accretive to the bottom line, especially considering the ad tier will monetize better than its basic and standard plans. The ad tier will be $6.99 per month plus ad dollars. With that, management believes there will be “50% or more incremental profit contribution to the business.”

Earnings Call:

According to management on the call, Q2 is the quarter to watch for password sharing.

“Yeah. So that launch we are doing in Q2 is a very broad launch, it includes the United States, includes many, many other countries. I mean, we reserve the right for some countries where we think there’s a different approach. But I would say the bulk of our countries, and certainly, when you think about it from a revenue perspective, the vast majority will be rolling out in Q2.”

The ad tier is expected to be accretive to the company’s margins at 50% or higher.

“Jessica Reif Erlich (moderator)

And then I just wanted to clarify something, Spence, I think you said, this is a 50% margin. I mean, typically, advertising could be as high as 80% or 85% margins. Is that — do you expect to build up to that or do you think it’s really just a 50%-plus business?

Spence Neumann

Well, I put plus in there. So I said at least 50% and it was really just to highlight the fact that we are still in startup mode of this business and so leaning a little conservative. But, yes, our expectations over time is that it would be meaningfully over 50%, but I don’t want to give a specific number yet.”

Conclusion:

The impact from password sharing and the ad tier is later than originally anticipated (Q2 for PW sharing and Q3/Q4 for the ad tier), but it’s not that surprising because these are monumental changes that require time. In this regard, we are happy to be patient. Part of the thesis was the bottom line and the cash flow, and the company has been performing here, as expected.

However, price was already looking stretched and we may trim the position according to technicals. The stock is up about 100% from the June low so the market may be getting antsy to pocket some of the gains from the second half of last year.

Netflix Q1 Earnings: Becoming an H2 Story (Like Most Stocks We Own)

Posted on April 19, 2023June 30, 2026 by io-fund

Netflix’s pivots – which is the password sharing and ad tier – are expected to show up in Q2 for password sharing and then Q3/Q4 for the ad tier whereas previously the goal was to have impact by Q1 and Q2. The initial signs of PW sharing are encouraging. More on this below. The ad tier is too early to have any initial impressions or data to work with, although long-term it will be accretive to margins and should have a positive impact on the top line, as well.
FCF was impressive at $2.17 billion with management raising the FY guidance to $3.5 billion.
Over the past few quarters, Netflix’s after hour price activity can be volatile. I believe this is due to FX headwinds, which are often reported as a miss, but then the market proves to be forgiving of the lower revenue/EPS numbers in favor of constant currency. This is my best guess as it’s been volatile for a few quarters, which leads me to believe machines are trying to catch up to the reported numbers versus constant currency basis. Notably, the stock price regained its losses before the earnings call was released.
The ad tier could see a flurry of headlines next month for the upfront season. The upfront season’s best-case scenario is committed upfront spend for 13 million subscribers, which is a small audience compared to Netflix’s roughly 220 million subscribers. Our plan is to follow price for this stock and to be patient long-term as we are optimistic on the outcome.
The I/O Fund has been planning on cutting back on our Netflix position, which was outlined before earnings here and also in Knox’s Position Report here.
The Netflix pre-Earnings report found here has additional information to supplement the post-earnings report below.

Financials:

EPS of $2.88 was in line. EPS for next quarter is a miss at $3.06 EPS expected versus $2.84 EPS guided.

In the comments on the forum, you can read from forum members on why margins are the most important line item for Netflix moving forward.

Key Metrics & Additional Notes:

Password Sharing & Geographic Regions:

Global paid adds of 1.75M came in slightly shy of analyst estimates of 1.8M.

The company stated that other regions, such as Canada, were “directionally consistent with what we saw in Latin America.”

There was a similar pattern in the United States Canada (UCAN) region where there was low net adds yet higher revenue growth. The region reported 0.1 net additions with revenue up 8% YoY.

In the year ago quarter, these regions were flat or reported a decline. There can also be churn coming out of Q4 for Netflix since that quarter has high net adds.

UCAN up +9% from $14.91 to $16.18
LatAm up +3% from $8.37 to $8.60
EMEA down (6%) at $10.89 this quarter compared to $11.56 in the year ago quarter
APAC down (13%) at $8.03 this quarter compared to $9.21 a year ago

Ad Tier:

Earnings Call:

According to management on the call, Q2 is the quarter to watch for password sharing.

The ad tier is expected to be accretive to the company’s margins at 50% or higher.

“Jessica Reif Erlich (moderator)

Spence Neumann

Conclusion:

April Stock Tip: Our Netflix Buy/Sell Plan

Posted on April 5, 2023June 30, 2026 by io-fund

Netflix is coming into a nail biter of a report. The ad tier will be under pressure in terms of how it’s performed in various regions when the company rolled it out in January. There is a report from Bloomberg that Netflix added 1 million in their first two months. An analyst noted below is expecting 1.75M total for the quarter. Overall, the goal is to reach 13M by Q3 2023.

Fundamentally, Netflix has become a different stock over the past year. In addition to the new advertising tier, which we hope is a catalyst, we own Netflix due to the underlying fundamental strength. According to analyst estimates, Netflix bottomed on revenue growth last quarter with noticeable improvement in H2 2023. The company has been transparent on how they will meet guidance on margins, including free cash flow.

The EPS is also rebounding with analyst consensus showing a 100% increase on EPS over the next two years. This is subject to change, but helps complete the picture as to why we’ve been covering Netflix closely.

Netflix is our largest position right now, thus we guard it closely. Our service is setup to show our Members what it looks like to realistically manage a portfolio. We do not provide an endless pipeline of stock tips. We carefully build positions and we carefully take gains, at times. We will gladly talk about the same stock dozens of times if it’s going to make us money.

Those who are addicted to a constant stream of information, and who are addicted to new stock tips, will get hurt in 2023. There simply aren’t that many great tech stocks in the current macro environment. If there’s anything you get from our service, I hope it’s that one important take away. 2023 is the year to hold fewer stocks, and to know them well.

Active management helps to participate in the gains. For example, to illustrate — Netflix is down (42%) from Jan 1st, 2022 and it’s up 61% from October 11th. This is why active management is well worth our time.

Buy Plan/Sell Plan – April Stock Tip:

By Knox Ridley

Between $379-$420, Netflix will be in the high-risk zone. Do not be shocked to see us cut NFLX in half if we get into that zone. If we do get there, this will be a 20% to 30% gain from when we recommended the stock for Essentials and a gain of 75% gain from our first entry in August on the Pro/Advanced side. Normally, our Essentials plan would have participated in the higher gains, but we had not launched the service yet. Our Essentials Newsletter went live around Thanksgiving.

Netflix is working on the final 5th wave of a very large degree pattern. It bottomed in May of 2022, so it has taken this pattern almost a full year to complete. Once NFLX gets into the $379-$412 region, the pattern will have met the minimum requirements for completion. We would consider that region to come with heightened risk. In fact, we expect to reduce our position substantially if we get to that price target. This will remain our primary thesis as long as price holds the $300 region. For long-term buyers, we believe the time to accumulate is not now.

What we are watching for:

There is outsized pressure on the advertising tier given the global rollout in test regions. Although password sharing was cutoff mid-quarter, Wall Street will want to see evidence this strategic move will be accretive. Per channel checks noted below, the Street is expecting 1.75M subscribers from the ad tier, although notably, Netflix no longer reports subscriber numbers.
Per Forbes/Bloomberg: “After a slow start Netflix ad tier has been gaining traction with U.S. subscribers. After analyzing their internal data, BloombergBloomberg reported in its first two months, Netflix had one million active users. Before its launch, Netflix had projected 1.1 million by year end 2022 increasing to 13.3 million by the third quarter 2023. Industry analysts project Netflix could eventually wind up with 30 million U.S. subscribers on its ad supported tier. The U.S. is one of the 12 markets where Netflix is now selling ads. At its most recent earnings report Netflix had 74 million total U.S. subscribers with 231 million worldwide.”
Netflix has been cutting costs this quarter. We want to see the company maintain bottom line strength. For Netflix, sometimes misses on the bottom line are due to FX headwinds, and other times they’re due to lumpy content costs.
Q1 is expected to be a weaker quarter for the year on operating margins with management stating “For Q1’23, we expect operating margin to be down year over year (20% vs. 25%) due primarily to the timing of content spend.” This would be 18-20% operating margin, down from a 25% margin in the year ago quarter.
Social media has a hard time dissecting the lumpiness in the new macro. Nvidia was a target for shorts because of this, what they didn’t realize is that NVDA had bottomed fundamentally in the prior quarter. In a nutshell, if the bottom-line miss is transitory – FX headwinds or lumpy content costs – the market will be more forgiving.
If Netflix’s management has guided correctly, the company has bottomed. I explain this more below (this depends on how management guided). Notably, this is the first quarter without Reed Hastings as CEO although the C-suite team has been working with Hastings for years on this transition.
The guide I’m referring to from the last earnings call is this: “So, that all lends itself to our focus, which is kind of healthy growing double-digit revenue growth and accelerating that revenue growth throughout the year, expanding our – both our absolute profit and profit margin and then growing positive free cash flow.

Financials:

Per analyst consensus, the expected acceleration is the following:

Estimated Revenue & Estimated EPS:

Q4: 1.9% Actual
Q1E: 3.86%
Q2E: 6.37%
Q3E: 10.57%
Q4E: 13.5%

On a fiscal year basis, Netflix is expected to report:

FY2022 Actual: 6.46%
FY2023E: 8.5%
FY2024E: 11.9%

This is not a hypergrowth profile, rather what the market will want to see is quality growth. For our purposes, this can be roughly defined as an acceleration in growth that doesn’t come at the expense of the bottom line.

For EPS, Netflix is expected to report:

Q3 Actual: $2.16 EPS
Q4 Actual: $0.51 EPS
Q1E: $2.87 EPS
Q2E: $3.06 EPS
Q3E: $3.30 EPS

I included Q3 since Q4 is often much lower than the other quarters. Although the revenue acceleration may be mild for growth investors, the bottom line is expected to grow well through FY2025. There’s a lot that has to happen between now and FY2025, but it’s good to see analysts have confidence that Netflix could double its bottom line over the next two years.

Q3 Actual was $2.16 EPS and consensus from six analysts is EPS of $4.08 in Q3 Sep 2024.

Gentle reminder that FX can result in an advertised EPS number being very low/big miss. Last quarter, the $1.15 EPS was reported as $0.12. Per the write-up: “

“FX can be a lot to unpack but I believe the market is taking into account the $462 million FX remeasurement and seeing this as $1.15 EPS rather than $0.12 EPS. This is why we want to do proper due diligence (and steer clear of social media for investment research — that's an understatement) as there was some confusion over this that negatively spiraled on Twitter.”

Margins:

Regarding margins, this is what the management said in full: “We have been targeting a FY23 operating margin of 19%-20% based on F/X rates at the beginning of 2022. We now expect to deliver roughly 21%-22% operating margin on this basis (above the 19%-20% range). Rolling forward to F/X rates as of January 1, 2023, this translates into a FY23 operating margin target of 18%-20%. For Q1’23, we expect operating margin to be down year over year (20% vs. 25%) due primarily to the timing of content spend.”

Last quarter, Netflix had a gross margin of 31%
The operating margin guide works out to 18% to 20% margin, down from 25% in the year ago quarter.
Due to FX headwinds, the FY2023 operating margin will be in the 18% to 20% range. The market has been forgiving FX headwinds, partly due to a global company being desirable for diversification while the United States see a weak consumer.
The net margin can be low at first glance due to FX headwinds. It was 20% in the year ago quarter yet was 1% with FX last quarter. Without FX, it was 6.5% last quarter. This included a $462M non-cash FX remeasurement.

Cash Flow:

Cash flow for FY2022 came in at $1.6B and management guided for $3 billion in FY2023. Last year, Q1 and Q3 were very strong on FCF and Q2 and Q4 were weaker. This goes back to lumpy content spend, so investors should be prepared for this and not expect a linear path to the $3 billion.

“But that’s what plays through and then also plays through that cash flow generation that you see, where we believe with all those dynamics and managing at about the same level of cash content spend that we will have more than $3 billion, at least $3 billion of free cash flow in the year.”

The $1.6B in FY2022 compares to ($158) million for FY2021. Overall, this is a very different Netflix today as the company lost over ($3) billion in free cash flow in 2019.

The in-house moderator also hinted toward “$4 billion plus in 2024” and management did not correct her. We would need an official guide but I have this number penciled in for next year.

The company’s gross debt is $14.3 billion and the company’s net debt is $8.37 billion or 1.3X LTM EBITDA with $6.05 billion in cash. You’ll notice the LTM slightly ticked up from 1.2X LTM last quarter. To reiterate, this is because Q4 tends to be weaker than other quarters. With the $3B in FCF expected in FY2023, Netflix can get the LTM below 1X.

The gross debt will still outweigh cash for some time. The company has stated investors can continue to expect $10 to $15 billion in gross debt. According to the last 10-Q, the company’s next payment of $400 million is due in October of 2024.

It’s understandable if you’re scratching your head at Netflix’s debt. This is part and parcel with Netflix’s business model. The market has come to accept this over the past decade-plus. You’ll have to decide for yourself if the business model works for your risk profile.

Noteworthy:

The upfront season starts in May. We covered this in December when we said:

“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.”

Reed Hastings has stepped down. Ted Sarandos and Greg Peters are Co-CEOs. Ted Sarandos became Co-CEO in July of 2020.

The revenue drivers being closely watched are the paid sharing (cutoff passwords) and the ad tier. Management stated they are expecting modest growth for Q1 on paid net adds for subscribers and a larger net add quarter in Q2. Seasonally, Q2 is a softer quarter for Netflix. Regardless, Netflix is no longer going to report on net adds. Instead, they expect analysts and investors to rely on revenue growth.

“As discussed in previous letters, we are increasingly focused on revenue as our primary top line metric. This will become particularly important heading into 2023 as we develop new revenue streams like advertising and paid sharing, where membership is just one component of our revenue growth. So, starting with our Q4’22 letter in January of 2023, we’ll continue to provide guidance for revenue, operating income, operating margin, net income, EPS and fully diluted shares outstanding for the following quarter, but not paid membership. Similar to our regional membership disclosure, we’ll continue to report our global and regional membership each quarter as part of our earnings release.”

Recent Headlines:

Per Bloomberg, Netflix’s ad tier reached 1M MAU after the second month. According to the report: “Most of the people signing up for the ad tier are new customers or lapsed customers, not people who immediately changed plans. The ad tier now accounts for about 20% of new sign-ups in the US, per Antenna.”

Also, per the Bloomberg report: “Netflix already has 74 million customers in the US, which means it doesn’t have that many potential new viewers. Analysts estimate the ad tier could bring in between 15 million and 30 million customers in the US, but that won’t be right away.”

My note: If it materializes, that’s some serious growth for a company that had plateaued. Reference above where management told advertisers to expect 1.75M by Q1 and Bloomberg reported up to 13 million by Q3 2023.

In February, Netflix tested lowering prices in a few regions. Per Reuters, “the price cuts took place in some countries in the Middle East, sub-Saharan African, Latin America and Asia.” See analyst note below where this was successful in India last December.

The company is scaling back on costs by restructuring its film group. Per Reuters, “Netflix will combine its small and mid-sized picture production units, cut a few jobs, scale back its output to ensure high quality titles and centralize decision-making.”

Netflix offers a video game service on smartphones and tablets, and is now bringing the video game service to televisions. Per Bloomberg: “Code hidden within Netflix’s app includes references to games played on TVs, signaling that such a plan is in motion. The code also mentions using phones as video-game controllers.” Per the report, the goal would be to attract and retain more subscribers.

Per TechCrunch, Netflix has 40 games ready to launch this year and 70 games in development.

What Analysts are Saying/Channel Checks:

“Netflix has told advertisers in the past 10 days that new sign-ups for the tier with ads had doubled in January over December, though Netflix didn't tell advertisers how many sign-ups that amounted to, people familiar with the matter told The Information's Sahil Patel. Last fall, when first pitching the ad offering, the company had told advertisers it expected the tier would draw 1.75M subscribers by the end of the first quarter, the equivalent of just 2.4% of Netflix's North American subscriber base at the end of December, the report noted.”

“Guggenheim analyst Michael Morris notes that over the past week, there have been several reports regarding Netflix pricing cuts across various markets in Eastern Europe, Latin America, and Southeast Asia, which is not the first time the company has changed prices. In December 2021, Netflix cut prices in India as it faced competition from other streaming services. Last week, co-CEO Ted Sarandos highlighted the company's success in India over the past year with viewership up 30% in 2022 and revenue increasing 25%, Guggenheim says. The firm believes Netflix is looking to extend this strategy across similar markets around the world. Guggenheim has a Buy rating on the shares.”

“Oppenheimer analyst Jason Helfstein thinks Netflix shares are at attractive levels after dropping 22% from the post-Q4 highs on fears around higher churn from enforcing password sharing and a slower advertising launch. The company's Q1 engagement is trending weaker than the previous two quarters, but in line with Netflix's previous six-quarter average, the analyst tells investors in a research note.”

“Citi analyst Jason Bazinet raised the firm's price target on Netflix to $400 from $395 and keeps a Buy rating on the shares. Netflix recently cut prices by 50% across 100 smaller markets, which represent 6% of its subscribers, the analyst tells investors in a research note. The firm believes "such dramatic" price reductions across so many markets "confused the Street." Citi thinks the price cuts are linked to password sharing enforcement and could boost Netflix's aggregate revenue by 1%. It says the "far more interesting question" is what Netflix will do in the 90 markets that do not have an advertising tier and have not received a large price cut. Netflix can either not enforce password sharing rules, launch an ad tier, or expand the price cuts, according to Citi. The firm updated its model to reflect the price reductions and updated current rates.”

“JPMorgan says there has been "considerable early pushback" around Netflix's Paid Sharing launches in select international markets, which is driving greater concerns around near-term churn. Apptopia downloads data suggests increased volatility across all four Paid Sharing markets since the rollout, and the headlines may also be impacting other markets where Paid Sharing has not yet been rolled out, including the U.S., the analyst tells investors in a research note. The firm sees potential risk to Netflix's projection for more net adds in Q2 than Q1. However, JPMorgan expects Netflix to continue down the path of transitioning users away from widespread account sharing. Ultimately it expects Netflix to generate more revenue through the combination of extra members and new standalone accounts. The firm recognizes the near-term "noise" but keeps an Overweight rating on the shares with a $390 price target.”

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