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Netflix - subscribers beat expectations

Second quarter revenue rose 8.6% to $8.0bn, compared to last year.

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Second quarter revenue rose 8.6% to $8.0bn, compared to last year. That reflects a 5.5% annual increase in subscribers, although the number of subscribers fell 970,000 compared to the previous quarter. That was better than previous guidance of a 2m drop.

The group also incurred $70m of severance costs and a $80m non-cash cost relating to the reduction in value of some office leases, as the group restructured over the quarter. Operating income fell to $1.6bn from $1.8bn.

The group's still targeting full year operating margins of 19-20%, and expects to add 1m subscribers next quarter.

The shares rose 7.9% in after-hours trading following the announcement.

View the latest Netflix share price and how to deal

Our view

The market breathed a sigh of relief as subscriber losses weren't as bad as expected. But there's a limit to the excitement. Nearly one million accounts have still rolled the credits on their subscription, and that's an indicator of how tough things are for the world's biggest streamer.

It's much harder to squeeze more revenue out of the group's biggest markets - pretty much everyone that will ever get a Netflix subscription in the US and Canada already has one. That puts the onus on emerging economies. This is a great growth opportunity- in fact India was the reason behind the subscriber beat last quarter.

But these regions generate much less revenue, and moving them up the scale when it comes to Average Revenue per User will take a lot of time and money. And Netflix's penetration in emerging markets will be dependent on broadband connections and smart-TV adoption - two factors over which it has no control. At the same time, while we can be accepting of slower growth in more developed economies, Netflix cannot afford for these customers to switch off completely.

We've been concerned for some time about Netflix's ability to keep viewers engaged. The group spent upwards of $17bn on content last year, and that's likely to continue rising with no back-catalogue of rewatchable hits to fall back on, unlike Disney+ or Amazon's new MGM Studios content. Netflix has to spend big just to keep hold of the customers it already has - let alone the cost of bringing new customers on board.

Gaming is a potential growth avenue, but it's difficult to quantify this as much more than a pipe dream at present. Without a firm plan in place, it doesn't add much to the investment case yet.

Another growth lever comes in the form of all the hundreds of millions of people watching Netflix for free. Account sharing is nothing new, but the group has plans to crack down on this, ultimately hoping to generate revenue from these ghost watchers. Introducing a new ad-tiered system is also the right move in our view. Today's cash-strapped consumer may well appreciate having a cheaper version to flock to as times get tougher.

Netflix is sporting a sizable debt pile, making it much harder to manoeuvre. This is particularly true given the rising interest rate environment. Investors will be waiting a while for the current $5bn share buyback to be extended in our view.

Netflix is an industry trailblazer, and as the world turns to streaming more permanently, there is potential opportunity ahead. For now, we'd like a bit more proof that Netflix has the right idea about how to sustain growth. In the meantime, we can't rule out some interest in the company from big tech rivals.

Netflix key facts

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

Second Quarter Results

Excluding the impact of exchange rates, Average Revenue per Membership (ARM) rose in every region except Asia Pacific, the strongest growth came from Latin America. The group's biggest market, the US and Canada, saw ARM rise 10% to $15.95.

Total costs and expenses increased significantly, with technology and development costs up over 33% to $716.8m.

Netflix also outlined plans to better monetise its platform, including introducing ad-free versions and cracking down on account sharing. Microsoft is the group's tech and sales partner as the tech giant invests "heavily to expand their multi-billion advertising business into premium television video."

$4.7bn was spent on additions to content. Free cash flow swung from an outflow of $175m to a $12.7m inflow, partly reflecting increased spending on content. On a 12-month basis, net debt was $8.5bn as of 30 June, and gross debt was within management's expectations of $10 - $15bn.

Of the wider environment, Netflix said: "Last quarter, we discussed our slowing revenue growth, which we believe is the result of connected TV adoption, account sharing, competition, and macro factors such as sluggish economic growth and the impacts of the war in Ukraine. We've now had more time to understand these issues, as well as how best to address them. First and foremost, we need to continue to improve all aspects of Netflix."

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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Written by
Sophie Lund-Yates
Sophie Lund-Yates
Lead Equity Analyst

Sophie is a lead on our Equity Research team, providing research and regular articles on a selection of individual companies and wider sectors. Sophie's specialities are Retail, Fast Moving Consumer Goods (FMCG), Aerospace & Defence as well as a few of the big tech names including Facebook and Apple.

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Article history
Published: 20th July 2022