In July, I no longer saw a screaming appeal for the streaming business of Netflix (NASDAQ:NFLX). The company saw some increased momentum in terms of net additions, in part driven by a crackdown on password sharing.
This was set to drive future growth, badly needed as expectations have risen substantially over the past year in anticipation of a tougher stance on password sharing and a contribution from advertising revenues, both of which appear to be lagging compared to expectations. This has resulted in severe share price pressure which increases appeal, just not enough yet to buy the dip.
A Roller Coast Ride
Pre-pandemic, Netflix was a $350 stock as the pandemic, which tied people to the comfort of their homes, sent shares to a high of $700 in 2021, only to trade below the $200 mark early in 2022. After a recovery to the $450 mark in July of this year, when I last checked on the shares, the same shares have given up quite some ground, now trading at a pre-pandemic level around the $350 mark.
In the meantime, Netflix has changed and grown quite a bit. The company reported operating earnings of $2.6 billion on $20 billion in sales in the pre-pandemic year 2019. Ever since shares have seen substantial growth as revenues grew to $25 billion in 2020, and operating profits rose to $4.6 billion, with strong operating leverage demonstrated upon.
2021 revenues rose to nearly $30 billion as operating earnings advanced to just over $6 billion. Amidst tougher comparables, the company saw much slower growth in 2022, with sales growing to $31 billion and change, as operating margins actually fell slightly, marking that net earnings fell a little bit amidst mid-single digit top line sales growth.
2023 has been another tough year from a top line perspective. First quarter sales rose 4% with net additions reported at 1.7 million members. Second quarter sales rose 3% to $8.2 billion, as net member additions rose to 5.9 million users, up to 238 million members.
While growth so far was not too exciting, there were some upcoming triggers. This included the company starting to launch paid sharing in over 100 countries, representing the vast majority of the revenue base. This will gradually start to make a top line sales contribution, as the company guided for 7% year-over-year sales growth for the third quarter. Moreover, the company saw accelerating sales growth in the fourth quarter, driven by these practices as well as an expected contribution from advertising efforts being rolled out.
With earnings of $6.18 per share for the first half of the year coming in fifty-five cents below the same period last year, earnings of $12 per share look attainable for the year. With shares having risen to the $450 mark over the summer, it was clear that expectations have risen substantially again to a multiple in the high thirties.
While there were some green shoots in the second half of the year, the reality is that these developments still have to pan out, notably an increase in the user base from cracking down on password sharing and incremental advertising revenues, although the extent of both items was hard to model. Given these concerns, a Hollywood strike on the horizon, households strained by inflationary pressures, and fierce competition, I was cautious.
Down A $100
Since July, shares of Netflix have fallen some hundred dollars to $355 per share. This marks a substantial pullback in a relatively short period of time, as we are awaiting third quarter results in the days to come.
Believing that earnings power of $12 per share is still intact, a high-thirty times earnings multiple has come down to about 30 times, still elevated. This comes as there have been multiple headwinds to the business, including a more strained consumer, as well as a prolonged Hollywood strike, and the advertising business reportedly growing slower than expected.
Besides these general headwinds, Netflix has seen more specific headwinds. This comes as a crackdown on password sharing is reportedly behind internal projections, as so far just 10 million subscribers are using the advertising subscription tier here. This has resulted in Netflix re-shuffling some executives, including the role of chief product and chief technology officer.
As it appears, subscribers are not too keen on the ad-loaded version comes at $6.99 per month, a huge discount from the $15.49 per month plan (which has been raised). In fact, all the major players in the streaming industry are raising prices (in part to offset inflation, as well as given the impact of the Hollywood strike).
Higher prices and having fewer content being supplied in the near term might push up churn, as these trends are causing pressure on the share price, with hopes for the third quarter results apparently not too high.
It is hard to imagine, but after a $100 decline, shares are back to the same levels at which they traded in May, while the signs for the third quarter quite frankly are not too good. Shares are now back to their pre-pandemic levels, amidst continued subscriber growth and more than 50% revenue growth, as valuations still remain demanding here.
Given this, I am getting more appealed to shares of Netflix here, but still find it way too early to get involved with the shares until multiples fall to the mid-twenties. While the long-term prospects of Netflix as an industry leader remain sound, the issue is that Netflix sees many headwinds and a fierce competitive field (albeit with more desperate and more challenged peers).