Netflix Q32022: A disconnected stream?
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Netflix has been a big rollercoaster of a stock over the past year, from the highs of ~$680 in November 2021 to the lows of ~$180 in June 2022. I have been keeping a keen eye on them for the past year and I think they have fixed/mitigated some of the structural challenges they were facing in their business.
I grabbed some at $190, $210, and $220 and my plan is to keep adding over time as the business keeps getting stronger.
So I think of Netflix as a business with network effects and a way to keep track of the strength/durability of network effects in general by observing 3 factors influencing the business over the long term, acquisition, engagement & monetization.
What I have observed from Netflix management is that they are ready to compromise on monetization for the short term in order to improve or strengthen their position over the long term. That is pretty evident in their choice to not monetize password sharing for so long.
Following are the results from Netflix's most recent quarter Q32022:
We can see that they fixed their user acquisition short-term problem and are back in growth mode, although slower than historical growth rates.
Also, they mentioned that Netflix's engagement has been 2.6x Amazon and 1.4x Disney. That tells us that their engagement strategy is way more effective as compared to other competitors.
I attribute that mainly to the content spend/Capex every year, I am a huge fan of this spending as it keeps them significantly ahead of their competition by allowing them to produce hit Netflix originals. I also think this is their core competency and core moat that they leverage with economies of scale of content production and distribution. Also, the Netflix originals themselves are IP, a significant barrier that strengthens their moat further.
They are launching an ad-tiered streaming offering in 12 countries(Cumulatively, these 12 markets account for ~$140 billion of brand advertising spend across TV and streaming, or over 75% of the global market) this leads to increased monetization.
Contrary to popular opinion, I think the ad tier, which is a new business for them, has the potential to grow even bigger than their current streaming business, and I believe this is their next avenue for powering better monetization of their products and generating even more revenue than previously thought of.
As mentioned earlier they have chosen to ignore password sharing for a long time and have come up with a solution to solve this problem by allowing borrowers to transfer their Netflix profile into their own account, and for sharers to manage
their devices more easily and to create sub-accounts (“extra members”), if they want to pay for family or friends. In countries with a lower-priced ad-supported plan, Netflix expects the profile transfer option for borrowers to be especially popular. This further improves their monetization power.
Another possible area for optionality is their gaming business, they own 35 games(and 55 are in development), a lot of studios, and a lot of great talent. I think they are doing the same as they did with the video media business, which was to vertically integrate to produce differentiated TV & Movies called "Originals", they are vertically integrating with the game media business to produce incredibly engaging games that will lead to further monetization potential in the future. We should see some more action here in the next 2-5 years from Netflix. Also, they might fail to monetize their IP in games, but I have a hard time believing they can't come up with a great model for both their free and paid users.
Amidst this formidable, diverse set of competitors, we believe our focus as a pure-play streaming business is an advantage. Our aim remains to be the first choice in entertainment, and to continue to build an amazingly successful and profitable business.
Netflix's capital allocation strategy is also pretty clear and suggests that the best days of their business, both in terms of revenue and stock price are still in the future(3-5+ years I think because of building out differentiated and profitable ad business and games business is a significant endeavor).
There’s no change to our capital allocation approach. Our first priority is to continue to invest appropriately in our business for the long term, including new initiatives such as games and advertising, followed by selective acquisitions. After that, excess cash above our minimum cash levels (equivalent to roughly two months of revenue) will be returned to shareholders through share repurchases.
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Chet @ Modern Growth Investing