Netflix: Advertising to become the main growth driver in 2026 (2Q24 earnings call)

The following is the summary of the second quarter financial report conference call for $Netflix(NFLX.US) in 2024. For financial report analysis, please refer to " Good performance but higher expectations, is Netflix a prelude to the Seven Sisters? "

I. Review of Key Financial Information:

II. Detailed Content of the Financial Report Conference Call

2.1. Q&A Analyst Interaction

Q: Can you discuss the trend of user churn and share the driving factors behind the revenue growth this quarter?

A: We are pleased with our performance in the second quarter. All aspects of the business are strong, with good growth momentum, significant revenue growth, member growth, and profit growth. Regarding member growth and churn, the net addition of paid members this quarter was mainly due to stronger user acquisition, slightly better than our expectations, while maintaining a healthy user retention rate throughout the quarter, this is the case in all regions.

In terms of overall growth, there are three key factors driving member growth. Firstly, our content performed well, with titles performing excellently across various genres and regions. Secondly, the positive impact of shared payments continues to show. Although we mentioned in the recent conference call that it is increasingly difficult to distinguish, we clearly see the healthy organic growth of the business. Lastly, we are improving in service enhancements and business value conversion, including converting unpaid accounts to paid accounts. For paid members, we may also benefit from the attractiveness of pricing points and feature sets of the ad plan.

In summary, this was a good quarter, not only in terms of subscriber growth, but more importantly in healthy revenue and profit growth. We reported a 17% revenue growth and a 5 percentage point year-on-year increase in profit margin.

Q: India ranked second and third in net additions of paid members and revenue growth percentage in the second quarter. Do you think this is a turning point for the Indian market, or is it simply due to the very successful content performance in the second quarter?

A: The growth story in India is very similar to what we see globally. The alignment of content and market is key to attracting and retaining members and achieving profitability. The performance this quarter is the result of long-term building. We have a great series "Heeramandi: The Diamond Bazaar", directed by one of India's most famous filmmakers, Sanjay Leela Bhansali, which is our largest series in India. Our original films and licensed films for the pay-TV window continue to be loved by members Our ability to select and organize content has increased market fit and user engagement, thereby promoting the growth of members and revenue. As long as we continue to surprise Indian audiences, there is great room for growth.

Q: Regarding operating profit margin, how is the pace of future profit margin expansion, and what drove the better-than-expected performance of profit margin this year?

A: We are satisfied with the trend of profit margin expansion. Our focus is on maintaining healthy revenue growth and increasing profit margin annually. Currently, our annual operating profit margin target is 26%, higher than the previous 25%, representing a year-on-year increase of 5 percentage points. However, the extent of annual profit margin expansion may fluctuate each year, influenced by factors such as foreign exchange fluctuations or other business considerations. Nevertheless, we are committed to increasing the profit margin each year and see room for continued profit growth in the coming years.

Q: Regarding free cash flow, Netflix has raised full-year revenue and profit margin expectations but has not changed the expectation of around $6 billion in free cash flow. Is this due to content spending being brought forward or are there other impacts?

A: There are no other impacts. We continue to expect full-year free cash flow to be around $6 billion. There is always uncertainty in the timing of content spending, such as tax timing. Therefore, we are maintaining the expectation of around $6 billion without any other interpretations.

Q: Regarding paid sharing, does Netflix still have room for growth in paid sharing plans? Has mobile paid sharing been launched? If so, what opportunities does this bring?

A: Speaking from a long-term perspective. We have already normalized paid sharing as part of the product experience. While there is still much room for improvement, we see these improvements as opportunities to enhance the product experience. We prioritize all these opportunities based on expected value. Even things we have been working on for over a decade, like the user registration process, we have found multiple improvements in the past few quarters that have brought substantial incremental revenue. We will continue to focus on all these opportunities to improve members and the business. We believe this is a value conversion mechanism that is constantly improving.

Q: In terms of advertising, you mentioned that advertising is currently not the main driver of revenue growth. Could you explain the significance of this for 2024 and 2025?

A: Looking back, we are very pleased with the expansion of our advertising business. Although the growth rate of advertising revenue is good, the base is relatively small as we only launched the advertising business 18 months ago. It will take time for advertising to become a major revenue driver. We have done well in expanding coverage, engagement, and inventory, which represents huge opportunities for the coming years. Advertising is a tool in our toolbox, and we are working to improve services to achieve growth in 2024 and drive 2025.

We currently have a small share in all aspects, a small share of TV time, a low penetration rate in TV households, a small market share of revenue, and we will grow comprehensively in these areas. Advertising will become a larger part. Advertising will not be the main revenue driver in 2024 and 2025, but it will be a meaningful contributor. By 2026 and beyond, advertising may become the primary contributor.

Q: What are the key areas for increasing advertising revenue? What opportunities and challenges are there in direct sales and using third-party demand sources?

A: Our primary focus is scale, and we have made significant progress in this area. We have rapidly expanded our advertising membership base and expect to achieve key scale targets in all advertising markets by 2025. We are now more focused on how to more effectively monetize rapidly growing inventory.

On one hand, in terms of market capabilities, we have increased sales and advertising operations personnel to provide advertisers with more effective ways to purchase Netflix. On the other hand, in terms of product and technology stack, we are building our own ad server, planning to launch in Canada this year and in other markets by 2025. This will unlock a range of innovations and enhance the experience for members and advertisers.

Q: Regarding the monthly viewing time of advertising members, you previously disclosed that the viewing time per account for ad-supported members is 10 hours per month. Considering the pressure of AVOD CPM, will you consider raising the price of the ad-supported tier as compensation?

A: First of all, to clarify, the engagement of our ad-supported plans is very similar to the non-ad-supported plans, with members globally watching about 2 hours per day on average. The Average Revenue per Member (ARM) for ad-supported members is currently lower than that of non-ad-supported members due to rapid expansion leading to inventory growth and lagging ad revenue. This is a growth opportunity for us as we expand, we can accelerate revenue growth. Regarding pricing, we price our ad-supported plans similarly to our non-ad-supported plans, with a preference for lower entry prices so more people can access Netflix content. As for raising prices, we will assess the appropriate timing based on member feedback.

Q: In the CTV advertising environment, how have advertisers responded to your advertising technology plans? What advertising technology features do you plan to add?

A: Advertisers are very excited about our work. We are responding to advertisers' demands by providing more ways to buy Netflix ads. In addition to ad-related features, advertisers are very interested in improving ad relevance, targeting, personalization, measurement, and more. We are also building our own ad server, which will unlock more innovations, improve member experience, and enhance advertiser capabilities. While these efforts take time, we are actively moving forward.

Q: Regarding your agreement with the NFL, do you need to broadcast sports events to build a strong advertising business? Or are you trying to attract advertisers through regular high-profile live events?

A: We entered the live streaming field because members enjoy it, which brings a lot of engagement and excitement, which is also important for advertisers. We have attracted advertisers through a series of exciting live events, which have also excited advertisers. We attract both viewers and advertisers through live events and expand our business while maintaining profitability.

Q: How do you attract advertising spending through live sports events without relying on renewing contracts for major events?

A: By turning sports events into Netflix-style activities instead of heavily relying on a particular league's events, we have avoided the renewal risks associated with large league events by creating an exciting day of competition. At the same time, we attract audiences and advertisers by telling sports stories.

Q: Can you talk about the health of Netflix's engagement levels?

A: The entertainment market is highly competitive, and we strive for every second of viewing time. Despite headwinds from shared subscriptions, our engagement levels remain stable, even showing some growth. We are pleased with the growth in engagement, but there is still room for improvement.

Q: YouTube is a major competitor in the realm of home entertainment. How do you compete with YouTube in terms of content and products?

A: According to Nielsen data, Netflix and YouTube lead in TV streaming. We primarily focus on the 80% of TV time that is not spent on either Netflix or YouTube. While we compete with YouTube in some niche markets, our services also complement each other. Our shows are very popular on YouTube.

Netflix offers consumers amazing movies and TV shows while providing creators with a platform to share risks. We compete with YouTube in certain business areas, but we are confident in our model, which is effective for consumers, creators, and our business.

Q: Netflix's CTO Elizabeth Stone recently mentioned on a podcast that Netflix is exploring integrating generative AI into the platform to enhance the member experience. Do you think this technology will have a greater impact on content creation or discovery?

A: We have been using similar AI and machine learning technologies for years to enhance the discovery experience. We believe generative AI has tremendous potential to further improve recommendation systems. Our goal is to make it easier for people to find wonderful stories that suit them. Additionally, AI can serve as a tool for creators to enhance story quality.

AI may provide creators with a range of tools to help them tell better stories. We believe that combining technology with entertainment can create greater business opportunities. Importantly, audiences value the quality of the story rather than the budget or technology.

Q: Can you explain the improvement goals of the new homepage?

A: The main goal of the new homepage is to provide a more flexible structure to support our increasing variety of entertainment. We aim to offer a better discovery and selection experience that adapts to different viewing scenarios. This will result in significant improvements, enhancing user engagement and retention, thereby increasing revenue.

Moreover, the new user interface is also very aesthetically pleasing, which is something we value.

Q: How are the early results of phasing out the basic tier progressing? How does this relate to the success of ad sales?

A: We have put a lot of effort into optimizing the migration experience, and then gradually rolled out tests to see the feedback from members. If the results are good, we will further promote it. The success in the United States and France has demonstrated this.

Q: Regarding games, can you provide the latest progress of the game plan, user engagement, and the ability to expand the gaming business?

A: The gaming market is very large, and our goal is to achieve significant growth in engagement over three years. We achieved a threefold increase in engagement in 2023, continued to grow in 2024, and set higher targets for 2025 and 2026. Although the scale is currently small, we are steadily expanding, and plan to launch more games based on Netflix IP.

The opportunities in gaming are very exciting. Through the gaming platform, we can provide an interactive space for super fans between seasons, and even introduce new characters and storylines that can appear in the next season or movie sequel. This is a very interesting opportunity to further enhance the fan experience.

Q: In terms of content spending, your cash content spending target for this year is $17 billion, including sports spending. How do you view entertainment or non-sports entertainment spending? How will future content spending growth be?

A: We are producing TV and film content for over 600 million viewers globally, which requires a lot of creativity. Our $17 billion content spending includes all these exciting contents and will grow with revenue but not faster than revenue growth. Our global creative team is working hard to produce content that appeals to local audiences while also potentially attracting a global audience.

Our shows like "Baby Reindeer" and "The Gentlemen" have been successful in the United States and the United Kingdom. Our content is not only popular locally but also attracts audiences globally.

In the future, we have exciting program schedules, including "Squid Game", "Emily in Paris", "Sunset Boulevard", "Lincoln Lawyer", "Diplomat", "Virgin River", "Masked Singer", etc. We will also launch new movies such as "Rebel Ridge", "Will & Harper", "Six Triple Eight", "The Piano Lesson", etc. Our goal is to spend the next $1 billion program budget in the best way possible, and Netflix is the best company at doing this.

We are not only excited about these programs but also aim to control the growth rate of content spending below the revenue growth rate.

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