Can Ads & Live Sports Keep Netflix (NFLX) Growing?

SPEAKER_1 (0:00)

Let's continue our breakdown of Netflix earnings hot off the press. Welcome in our next guest, Dan Rayburn, streaming media analyst. Dan, what's your first take on these numbers?

Dan Rayburn (0:08)

Thanks for having me again. Well, I mean, it's a great quarter, but you have to really look at two things, the quarter and the projections. What stands out to me is the operating leverage. So Netflix increased revenue 12 percent, operating income grew 37 percent. So the fact that Netflix is converting a larger share of its revenue to operating profit, that's definitely a good thing. The weaker guidance in Q4, advertising revenue forecast has been reduced.

So that's something we don't like seeing. Also, the company did lower its full year free cash flow outlook. However, it's important to point out here that management said that's because of expected timing of a real estate transaction in Q4. So it actually wasn't a weaker operating performance. I like that Latin America delivered the fastest reported growth while the other regions were at double-digit rates and continuing that. But I think what Wall Street is really looking at, they're down what, a little over 3.5% right now, what Wall Street is really looking at is Q4 and going into the next year.

SPEAKER_3 (1:04)

And as we look at Q4 and going into the next year, because we no longer have these subscriber numbers to work off of Dan, what metrics are you narrowing in on to try to determine the health of the business? I know you mentioned some of their international metrics, and we were just talking to Kevin Green about the possibility of an announcement of raised prices perhaps and what that might do.

Dan Rayburn (1:24)

Yeah, it's a great question, and I think far too many people are just looking at the engagement metric right now, which everybody defines very differently. In the first half of this year, based on Q2 revenue that numbers Netflix gave us, engagement was up 2%.

Okay, so engagement's still growing, but the rate of growth has been declining. I would really look at the ad business, because we know that the ad business has a lot of growth. The real question is how quickly can they scale that? They did announce a couple weeks ago that they were expanding the ad tier in 15 additional countries, and also in the UK last month, they already raised pricing. So I don't know how many more price increases they can do anytime soon. They've already done quite a bit, as has every streamer out there. But I think what you have to look for going forward is just how much of this is turning into an operating profit versus growth message. And also, can they expand the ARPU per customer?

Because if average revenue per customer goes up, which they no longer give us that metric either, it's okay if they don't grow as quickly in terms of the total number of subs, revenue will still grow faster.

SPEAKER_1 (2:28)

So it's interesting, obviously, what they're trying to do around pricing. And some would argue, I was listening to the folks over at Deutsche Bank just a couple of weeks ago, who seem to think that they have the international momentum. I mean, I didn't know that over 60 percent of Netflix's content is now produced outside of the US. So perhaps they have the pricing power here. But when you think about what Netflix has to do, I mean, there is a view that they need more hits. They need to stay on top of where the culture is at. They need to look at the creator economy. They need to look at YouTube, which is where people are actually going, particularly the young people.

Is that what you're seeing? I mean, what do they need to do? What do they need to lean into in order to really reassure the street about what the strategy is moving forward?

Dan Rayburn (3:13)

I don't know if they can really reassure the street. Keep in mind too, I think the street knows very well. The Netflix plays a long game here. They've never done anything, whether it's a press release or a hire or letting somebody go based on short-term gains. They've always played the long game here, and we have to think about far too many people right now are comparing them to YouTube, a service that is completely free with short form content where the average video viewing time is nothing close to Netflix against a subscription service. It's not an apples to apples comparison.

Is YouTube taking away from engagement time? Yes, but so is every other streaming service because we all only have so many hours in the day to watch content. I think when Netflix has to do on the call, which is coming up in 30 minutes, is they have to say why they made all these changes at the executive level that they did, what happened in terms of doing approximately 1,000 employee headcount reductions, and what that means for the business going forward. I think that's the biggest thing Wall Street wants to hear is, is the strategy changing based on bringing in new key executives and making the company leaner.