Netflix: Strong at the moment, but about to "deflate"?

$ Netflix(NFLX.US) released its first-quarter financial report for 2024 after the market closed on April 18th Eastern Time: Based on strong supply of high-quality content, core indicators such as net user additions, revenue, and operating profit all significantly exceeded Bloomberg's expectations. However, the stock price fell by more than 4 points after hours, indicating that the market was not satisfied with the financial report.

In response to this issue, Dolphin Jun will first explain that we believe the market's disappointment is not with Q1 performance itself, but mainly with two points regarding future outlook and expectations:

(1) Discontinuation of Key Operating Metrics Disclosure Next Year

This has the biggest impact on market sentiment. Starting from the first quarter of 2025, the company will no longer disclose user numbers and average revenue per user. Management explained that future operating goals will focus more on overall revenue and profitability. After the introduction of the advertising model, different operating strategies will be adopted for different regions. As advertising revenue as a proportion increases in some regions, the guidance effect of single user volume and average revenue per user on revenue expectations is relatively low.

However, the market still interprets this change as a signal that future user growth will significantly slow down, reaching a plateau or bottleneck phase. Targeting 500 million households and 1 billion users, but stopping the disclosure of data when the process is only halfway through will undoubtedly undermine the market's long-term growth confidence in Netflix.

As compensation, the company will start disclosing annual revenue guidance from this quarter, expecting a 15% revenue growth in 2024 (initially expected 13%), and raising the operating profit margin target from 24% to 25%. The company's annual guidance is similar to current market expectations and does not bring positive momentum at the moment.

(2) Q1 "Exceeded Expectations" Not as Much, Q2 Revenue Guidance Miss

In terms of first-quarter performance indicators, net user additions (9.3 million) exceeded consensus expectations (4.5 million) the most. However, the actual situation is that with third-party data platforms already showing that Netflix's recent user metrics growth is good, core institutional expectations have gradually increased from 4 million to 6 million, and even more optimistic buyer expectations have reached 8-10 million. In this regard, the "value" of Netflix's Q1 exceeding expectations has decreased.

At the same time, the company's revenue guidance for the second quarter is slightly below market expectations. However, Dolphin Jun believes that the expectation gap is within an acceptable range and does not create a bearish investment logic. Therefore, the main reason for the post-market decline may still come from the operation of discontinuing the disclosure of key operating metrics.

Specifically:

1. Off-season not weak, user growth continues to be "explosive"In the first quarter, Netflix added 9.33 million net new subscribers. As the off-season, this year's performance is significantly stronger compared to previous years, not inferior to the peak season last year. Dolphin Jun had already hinted in the previous quarter's financial report review that due to the high-quality content with good feedback in the fourth quarter of last year, which was launched relatively late, the popularity is relatively easy to sustain into the first quarter, thereby driving the growth of users in the first quarter.

However, with the strong performance exceeding expectations in the previous quarter, coupled with the good data shown by third-party platform monitoring, market expectations are rapidly rising. Although Bloomberg's consensus expectation is 4.8 million, the latest expectations from core institutions are generally around 6-8 million, with some buyers being more optimistic, expecting between 8-10 million. Therefore, the actual net increase of 9.33 million may be considered inline performance in the eyes of buyers with pricing power.

Looking ahead, the second quarter is also an off-season, with market expectations at 3.73 million (institutions have not made significant adjustments to their latest expectations), showing a slight decline compared to the first quarter. The company's management also estimates that due to seasonal factors, the performance will be weaker than the first quarter.

2. Whether in the South or North America, price hikes do not dampen user demand

There was a certain increase in average per capita payment in the first quarter, mainly driven by the price hikes in the core European and American regions in October last year. In other regions, especially in Latin America, due to currency depreciation, as well as the introduction of lower-priced advertising packages and measures to combat account sharing, there are more audiences, and the average per capita payment is still declining.

It is worth mentioning that the North American region has exceeded expectations for several consecutive quarters. In the past, North America was the first mature market penetrated by Netflix, so by 2023, user growth had already slowed significantly, especially under multiple rounds of price hikes. However, starting in 2023, with the introduction of advertising packages and the widening advantage of high-quality content relative to competitors, price hikes have not stopped but instead stimulated a wave of demand from North American users.

Considering that 1Q24 itself is an off-season, and users are truly beginning to feel the impact of price hikes, theoretically, user growth in the North American region should have slowed significantly, as the market originally expected. However, in reality, it has not slowed much, but instead become the leading region in Q1 user growth.

Of course, the overall performance still heavily relies on the North American region + the challenging growth responsibilities in Latin America and the Asia-Pacific region, which has also raised some market doubts about growth. If the growth in emerging regions does not continue to expand, then Netflix's future growth can only rely on 1) price hikes and 2) advertising, which undoubtedly places higher demands on maintaining a competitive edge in content.

3. Accelerated improvement in revenue, double-digit growth expected this year

The significant increase in users, the halt in ARPU decline, combined to achieve a 14.8% year-on-year growth in Netflix's total revenue in the first quarter, slightly exceeding expectations. The company's revenue expectation for the first quarter of this year is 9.49 billion, with a year-on-year growth rate of 15.9%, slightly lower than the market's expectation of 9.51 billion.

Strategically, Netflix hopes that by 2025, advertising revenue can become a strong support for the company's revenue. However, it is currently in the stage of penetrating users and expanding traffic scale. From the market where advertising packages have been introduced, 40% of registered users are already ad-supported usersThe management disclosed new annual revenue guidance for the quarter, expecting a 15% year-on-year increase in group revenue in 2024 (approximately 39 billion), up from the original internal expectation of 13%. Although the company raised its growth target internally, the revised guidance is basically in line with market expectations.

4. Competition is easing, profitability is still in the dividend period

Netflix achieved an operating profit of 2.63 billion in the first quarter, a significant increase of 54% year-on-year, mainly due to the scale expansion brought by the simultaneous increase in volume and price on the revenue side. That is, with almost the same content costs, more positive feedback can be obtained. The gross profit margin in the first quarter has reached 47%, a historical high.

At the same time, overall operating expenses have not changed much. Although marketing expenses for the quarter were slightly higher than in previous years (marketing promotions for games, sports, live broadcasts, etc.), administrative expenses and research and development expenses remained relatively restrained, so the overall absolute amount did not fluctuate much, and the expense ratio continued to be optimized.

Following the increase in profit targets last quarter, due to confidence in the content reserves for 2024, the management once again raised the full-year profit margin target from 24% to 25%. Dolphin believes that the core reason Netflix can continuously break through the profit ceiling is still the current easing competition period, where peers are not reinvesting but rather increasing external content licensing.

Therefore, Netflix can rely on self-produced exclusive content to increase prices and attract viewers on one hand, and on the other hand, it can optimize cost expenses by enriching supply through peer licensing and reducing its own investment.

5. Restart investment, stop the shrinking of content asset scale

At the beginning of the year, the company set a target of 17 billion in content investment for this year. Therefore, compared to last year's 13 billion, there will be a significant increase in money spent on content this year. The data for the first quarter can already verify this - a single quarter content expenditure of 3.9 billion, relatively high compared to the same period in previous years. As a result, the content asset scale at the end of the first quarter is no longer declining compared to the previous quarter, but is basically flat compared to the end of last year.

The company's free cash flow in the first quarter was 2.14 billion, although it hit a record high, the company's target of 6 billion in free cash flow for the full year remains unchanged on the surface. This means that in the remaining three quarters, Netflix will be more open-handed in external investments.

In terms of non-operating cash outflows, the company repurchased 3.6 million shares in the first quarter, using approximately 2 billion US dollars, which may be slightly less aggressive compared to the previous two quarters due to the strong stock price. As of the end of the first quarter, the company had 14 billion in debt (95% long-term debt) and 7 billion in cash (very little in other cash assets such as short-term investments). Although net cash is negative, there is no financing risk in the short to medium term due to the low short-term debt and positive free cash flow in operational terms.

6. Performance indicators overview

Dolphin Research Viewpoint

In fact, Netflix's performance in the first quarter was very good, but the disclosure of key operational indicators has changed, slightly shaking the market's confidence in its long-term growth.

Dolphin believes that the market's concern this time is not actually a realized negative factor, nor does it hurt the logic too much (short-term logic is smooth, at least this year, Netflix's competitive advantage is still obvious, while the long-term logic still mainly follows the trend of cutting the cord, and Netflix relies on its internal operating mechanism to continue maintaining its content advantage). The post-market fluctuations are mainly due to the relatively full expectations and the fact that the valuation is not cheap.

Compared to the valuation at the time of the last quarterly report review, the market's adjustment to EPS is not significant, but Netflix's valuation multiple, that is, the PE relative to the 2024 performance, has increased from 30 times to 35 times. Apart from the market's overall liquidity reasons, the main reason is that the market has raised its expectations for Netflix's long-term growth.

Dolphin believes that although the change in operational indicators' disclosure range and the signal it conveys are not very positive, looking at the key factor that ultimately determines the company's performance—changes in competition, it is still in a relatively relaxed window period (within a year).

Similar to the viewpoint in the 4Q23 financial report review on February 2nd, Dolphin believes that Netflix is still in a fundamentally favorable stage. Combining the compound growth rate over the next three years and the valuation levels of previous years, it is not difficult to stabilize at a 30x PE for 2024, which is a market value of 240 billion. Going further would require enduring more potential risks and fluctuations. The key is still to focus on competition, that is, the risk of the competitive landscape tightening as competitors emerge from the buffer period. Perhaps Netflix can still maintain its competitive advantage in the end, but the pace of price increases and content investment is no longer as relaxed as in the past year.

Below is the detailed content

I. Off-season not light, user growth continues to be "explosive"

In the first quarter, the net increase in subscription users was 9.33 million, exceeding Bloomberg's consensus expectation of 4.8 million. However, the market's latest expectations have significantly increased to 6-8 million, so the significance of the outperformance is not as high. User growth still stems from cracking down on password sharing and the launch of ad packages.

Looking at different regions, Europe and America are still the main drivers of growth, with North America and Europe adding 2.53 million and 2.92 million people respectively. Dolphin believes that in addition to the effect of cracking down on account sharing, it is also related to Netflix gradually canceling basic packages in mature regions such as the United States and the United Kingdom since July last year to expand the coverage of ad packages.

The ad package provides users who used to share accounts with friends a lower payment threshold, so the subscription package has received a good response since its launch. In January this year, the company announced that it had reached 23 million ad users, a 53% increase from 15 million in November last year. This financial report disclosed that Q1 ad users grew by 65% compared to the previous quarter (3Q23 and 4Q23 quarter-on-quarter growth rates were both 70%), implying that the scale should have exceeded 30 millionIn addition, the company disclosed that in regions where advertising packages have been launched, the scale of advertising users has reached 40%. Following this growth trend, it is expected to reach 50 million users by the end of the year.

For the second quarter of 2024, the company has not provided specific user guidance yet, and it is expected to be weaker than Q1 2024 due to seasonal factors. Market expectations are around 3.73 million (the latest expectations have not been adjusted much), which is lower than Q1.

Dolphin believes that in the second half of the second quarter, the hit drama series "Bridgerton" Season 3 is expected to continue the performance of the previous two seasons and bring a wave of user subscription peaks. In addition, Netflix's self-produced boxing show "Jake Paul vs Mike Tyson" will be launched in the third quarter, with the potential to increase popularity. Therefore, although the second quarter may be weaker, the net increase in users in the third quarter is still worth looking forward to.

In the medium to long term, the main logic remains the replacement of cable TV by streaming media, and Netflix's maintenance of competitive advantages and industry-leading position in streaming media. According to Nielsen data, although the share of streaming media viewing time did not increase as quickly as during the pandemic in the past two years, the overall trend of continuous penetration remains unchanged, with cable TV occasionally regaining some share in months with intensive sports events.

However, considering that streaming media giants such as Netflix and Amazon are increasing their layout of sports content, and the giant Disney, which follows the two-step strategy of traditional channels + streaming media, is also accelerating the migration of sports content from cable TV to streaming media, the future trend of cord-cutting is expected to become clearer.

Secondly, whether it is North America or elsewhere, raising prices does not extinguish user demand.

In the first quarter, Netflix achieved a total revenue of $9.37 billion, a year-on-year increase of 14.8%, and a continued acceleration on a quarter-on-quarter basis. The DVD business, which was completely closed by the end of the third quarter, has returned to zero revenue, leaving only the subscription business. It is expected that the proportion of advertising revenue will significantly increase after 2025, and we speculate that the company may separate advertising revenue by then.

The price increase effect that was not reflected in the previous quarter's performance (a unified price increase in core regions of Europe and America in October 2023) showed clear signs in the first quarter—average per capita spending in North America and Europe increased, but the net increase in users did not significantly slow down, which was surprising.

In most other regions, they are still within the impact period of price reductions at the beginning of the year and the penetration of low-ARM advertising packages. However, in the first quarter, due to the devaluation of the local currency in Argentina, Netflix significantly raised prices, but the impact was limited for that quarter

Strategically, Netflix hopes that advertising revenue will become a strong support for the company's revenue by 2025. Looking at the business structures of streaming services such as Hulu and Spotify (where advertising revenue accounts for 36% and 13% respectively), Netflix still has the potential to contribute a considerable share of revenue through advertising in the future.

The monetization ability of advertising is highly related to traffic. Currently, the company's strategic goal is still to expand its user base. Therefore, this year, they will accelerate the transition from basic plans to ad-supported plans. Drawing from Hulu's experience, the Average Revenue Per User (ARPU) of ad-supported users tends to be higher than that of basic users. This indirectly improves the company's monetization efficiency and profit margins.

However, if Netflix enters the advertising space, its competitors will not only be traditional film and television giants but also Big Tech companies. As of now, Netflix still lags behind in terms of advertising user scale compared to them. If they accelerate promotion in the short term to make up for this gap in user scale, it also means that if the monetization level does not keep up with the rapid expansion of the advertising user base, it will result in lower ARPU and affect short-term profit levels.

III. Competition Still Has a Dividend Period

Due to various reasons leading to a slowdown in industry competition, for Netflix, which has content advantages, it is indeed a dividend period. Dolphin Jun discussed this in detail in the previous quarter's financial report commentary "Netflix: Content Dominator with a Strong Foundation, Unafraid of Challenges". Therefore, the question for this year is, how long can this dividend period last?

Dolphin Jun believes that for most of this year, Netflix can still continue to enjoy the dividend of a relaxed competitive landscape, not only due to the content production cycle window caused by strikes but also based on the slowdown in interest rate cuts, average performance of the U.S. film market in the first quarter, and the ongoing competition for advertising share in cable TV channels by social media platforms under the AI trend. Therefore, for traditional content giants with the aforementioned businesses, the likelihood of coming out of the trough and engaging in a content arms race is decreasing due to the overall profitability demands of the group, and the timing is being postponed. This can also be seen from the recent statements of management at Disney's latest earnings conference.

Apart from traditional film and television giants, in terms of share of viewing time within the streaming media industry, Netflix maintains its consistent leading position, closely following YouTube. However, there are significant differences in functionality/content between the two for users, so they cannot be simply categorized as direct competitorsAt least in the field of professional film and television content, Netflix's advantage is still obvious. The same trailer for film and television content can achieve 40 times the views on YouTube.

IV. Restart investment, stop the shrinking of content assets

At the beginning of the year, the company set a target of 17 billion yuan for content investment this year, so compared to last year's 13 billion yuan, the money spent on content this year will see a significant increase. As expected by Dolphin, there were signs in the fourth quarter of last year, and the data for the first quarter of this year can already verify this - a single quarter content expenditure of 3.9 billion yuan, relatively high compared to the same period in previous years. Therefore, the direct result is that by the end of the first quarter, the scale of content assets has stopped declining compared to the previous quarter and is basically flat compared to the end of last year.

Although some market views are cautious about the impact of increased investment on profitability, Dolphin believes that for entering a new round of content investment cycle, it should be viewed positively in the long run. The current investment is for the future 1-2 years of content reserves. As long as the content reserves are rich, the competitive position will be more stable.

From the current pipeline, it can be seen that in the second half of the second quarter, especially starting from the third quarter, there are no shortage of sequels to high-scoring explosive dramas such as "Bridgerton S3", "Squid Game S2", "Empress S2", as well as live self-produced sports programs. With competition maintaining a relatively relaxed pace, Netflix's content reserves this year are expected to continue to support considerable user growth.

Of course, one direct impact of returning to investment expansion is on short-term cash flow. Although the company has raised its expectations for revenue and profit in 2024 this time, there has been no corresponding increase in the size of the 6 billion yuan free cash flow. Conversely, this proves that the investment in content this year will only increase and not decrease.

In the first quarter, Netflix's free cash flow net inflow was 2.1 billion yuan, with cash on hand of 7 billion yuan, debt of 14 billion yuan, but 95% of it is long-term debt, and short-term debt is maintained at a single-digit scale. Therefore, although the funds are not very abundant, maintaining normal operations + content investment + repurchases (around 2-2.5 billion yuan per quarter) is basically unimpededFive, the continuous increase in profits is behind the competition dividend

In the first quarter, Netflix achieved an operating profit of 2.63 billion, a significant increase of 54% year-on-year. Both the absolute amount and profit margin level reached new highs, essentially due to the high quality of content, especially compared to peers in the same period.

In terms of expenses, apart from a 18% increase in marketing expenses spent on promoting advertising packages, self-produced live program content, gaming, and other customer acquisition businesses, other changes were minimal.

Ultimately, the operating profit margin increased by 7 percentage points compared to Q1 last year, reaching 28%. The company's guidance for the full-year operating profit margin is 25%. The full-year figure is lower than Q1 because in the second half of the year, when there is more content supply during the peak season, higher amortization costs will lead to a lower profit margin level.

Content advantage brings competitive advantage, and competitive advantage brings higher profitability. With confidence in the content reserves for 2024, after two consecutive adjustments, the management has further raised the original 2024 operating profit margin target from 24% to 25%.

Dolphin Research on "Netflix" Historical Articles

Earnings Season

January 24, 2024 Conference Call "Netflix: Expanding content investment, using good content to drive price increases (Netflix 4Q23 conference call summary)"

January 24, 2024 Earnings Review "Netflix: Content giant with a solid foundation, real gold fears no fire (Netflix: Content giant with a solid foundation, real gold fears no fire)"

October 19, 2023 Conference Call "Netflix: Hoping to return to the original investment level to drive growth (3Q23 performance conference call summary)"

October 19, 2023 Earnings Review "Growth questioned? Netflix fights back with price increases"July 20, 2023 Conference Call "The Effect of Cracking Down on Account Sharing Will Further Emerge (Netflix 3Q23 Performance Conference Call Summary)"

July 20, 2023 Financial Report Review "Netflix: Squeezed User Growth, Market Unconvinced?"

April 19, 2023 Conference Call "Focus on the Prospects of Advertising and Account Sharing Fees (Netflix 1Q23 Conference Call Summary)"

April 19, 2023 Financial Report Review "Freeloaders Difficult to Crack Down, Netflix Stagnant"

January 20, 2023 Conference Call "Senior Management Changes Do Not Affect Content Strategy, Targeting Advertising Revenue Share of Over 10% (Netflix 4Q22 Conference Call Summary)"

January 20, 2023 Financial Report Review "Hit Shows Save Advertising, Netflix Perfectly Interprets 'Content is King'"

October 19, 2022 Conference Call "Netflix: In Addition to Advertising, Will Focus on Cracking Down on Account Sharing Next Year (3Q22 Conference Call Summary)"

October 19, 2022 Financial Report Review "Netflix: Encountering Another Surge Against the Trend, Good Content is the Real 'Panacea'"

July 20, 2022 Conference Call "The Advertising Model is Netflix's New Story for the Future (Conference Call Summary)"

July 20, 2022 Financial Report Review "Netflix: Performance Not Thunderous, But Celebration Not Necessary Either"2022 年 4 月 20 日电话会《Focus on how to increase revenue, actually "expose" the lack of confidence in user growth (Netflix conference call summary)》

2022 年 4 月 20 日财报点评《A 25% overnight plunge, Netflix's logic collapses》

2022 年 1 月 21 日电话会《Management says guidance expectations gap stems from pandemic-induced forecasting uncertainty (Netflix Q4 earnings call summary)》

2022 年 1 月 21 日财报点评《A 20% plunge? Netflix becomes a copycat of iQiyi》

2021 年 10 月 20 日电话会《Ambitious, Netflix's next target is to learn from "Disney" (Q3 earnings call summary)》

2021 年 10 月 20 日财报点评《Netflix: The return of the streaming media overlord, is it accidental or destined?》

2021 年 7 月 21 日电话会《Netflix Q2 earnings call summary》

2021 年 7 月 21 日财报点评《Guidance remains conservative, when will the king of Netflix return in the post-pandemic period? | Dolphin Research》

2021 年 4 月 21 日电话会《Netflix Q1 earnings call Q&A: Check out management's answers to user growth issues》

2021 年 4 月 21 日财报点评《After the end of the epidemic dividend period, Netflix's user growth has stumbled》

In-depth

2022 年 2 月 16 日深度《The battle of the consumer internet "roll kings", Meta, Google, Netflix fighting with bayonets》November 23, 2021 in-depth article "Long Video Battle is Coming 'American Version', Netflix, Disney in Trouble?"