Netflix (NFLX. O) released its financial report for the first quarter of 2023 in the early morning of April 18, Beijing time. In the past quarter, Netflix's business actions have been not small, advertising, account sharing, and sharp price cuts in some regions. Therefore, the market is more concerned about the effect of the actual landing on the performance after an operation:
Overall, the effect was lower than expected.
The advertising effect is average, this has already appeared at the end of last year, of course, this is also related to the macro environment.
But this time it is mentioned that the paid-sharing program launched to combat the problem of free account sharing may be resisted by users in the short term, which in turn will trigger a wave of unsubscribing.
Although Netflix said that the experience of countries and regions that advanced ahead shows that subsequent user subscriptions will resume and bring new ones, it will inevitably drag down short-term results.
From the perspective of market expectations, it seems that the impact of this has not been taken into account, coupled with the relatively low season content in the second quarter, so the company's performance guidance for the second quarter is lower than the current market consensus expectations. According to the "unsubscribe to resume" time trajectory of Canadian users, it is expected that the data in Q3 and the second half of the year will be better.
In addition, at the point of the new investment cycle, the decision to reduce content investment in order to preserve cash flow may also affect content output in the short and medium term.
Specifically:
(1) The number of users in the current period and guidance was weaker than expected: the net increase in users in the first quarter was 1.75 million, less than the guidance of 2.3 million, and some investment banks were even more optimistic. Latin America, which has the largest expectation gap, may be related to the impact of last quarter's price increase and the crackdown on account sharing, which was expected to increase by 500,000 and actually lost 450,000.
The company expects subscriptions in Q2 to be similar to the first quarter, but this is below market expectations (~3.43 million), and from the company's tone, this guidance for user growth takes into account the short-term impact of the implementation of the account-sharing program in the four new countries (user resistance to unsubscribe), and believes that the positive effects of these measures will be felt in Q3.
(2) The expected difference in the number of users leads to the expected difference in revenue: revenue in the first quarter increased by 3.7% year-on-year, excluding the impact of exchange rates, the growth rate was 8%, which slowed down to a certain extent from the previous quarter, slightly lower than market expectations, of which the expected difference in the number of subscribers was the main drag.
For the revenue in the second quarter, the company's guidance was 8.24 billion yuan, a year-on-year increase of 3.4%, and the growth rate was 6% under constant exchange rates, which was far from market expectations (~8.49 billion). In detail, the number of user subscriptions and the amount paid by a single user are weaker than expected. According to Dolphin Jun, the main reason is that the market has given less consideration to the short-term negative impact after the launch of the account sharing program, and slightly overestimated the performance of advertising.
In addition, the traditional DVD business has been steadily declining for many years after the rise of streaming, so the company decided to shut down completely in the fourth quarter of this year.
(3) Restrained marketing, profits exceeded expectations: Although the revenue was not as high as expected, because of the restraint of marketing launch, the operating profit in the first quarter was better than expected.
However, due to the "pressure" on the revenue side relative to market expectations, the company's guidance for operating profit in the second quarter is naturally weaker than expected. However, full-year operating margin guidance remains in the 18-20% range.
(4) Intentional reduction of content investment to release more cash flow: FCF net inflow in the first quarter was 2.1 billion, which suddenly soared mainly due to the reduction in spending on content investment, which was about 1.5 billion less than normal.
The previous content investment plan was 17 billion yuan per year from 2022 to 2024, and it is expected to be reduced this year, so that the net free cash flow target for 2023 has also been raised from 3 billion to 3.5 billion yuan, and the investment target for 2024 will remain unchanged for the time being.
But the embarrassing thing is that Netflix is approaching its new investment cycle, will reducing the budget at this time affect content output in the medium term?
(5) The pressure of debt repayment after abundant cash flow is lighter: the company's net debt (cash assets - long-term and short-term debt) at the end of the fourth quarter was 6.7 billion, a decrease of 1.6 billion yuan from the previous quarter. The earliest maturity is a 400 million senior notes that need to be repaid in March 2024, but due to the significant improvement in free cash flow for now, short-term debt servicing pressure is not great.
(6) Under the retention of the established cash limit, invest first and then buyback: In the first quarter, in addition to operating cash expenditures, it continued to repurchase 1.2 million shares of the company's shares, consuming 400 million yuan in cash. In the future use of funds, the company still chooses to keep the basic cash amount equal to about 2 months' income (about 5.4 billion according to the Q1 income standard), and the excess part is refunded to shareholders through the repurchase of the company's shares.
Longbridge Dolphin-kun view
The most obvious problem in the first quarterly report is that user growth is less than expected, because the market underestimated the short-term user loss caused by account sharing. Fortunately, peers have not made much benefit, so it can be said that Netflix's content advantage is still as high as ever.
But the problem is again, when a new content cycle is approaching, Netflix's option is to reduce the investment budget. Although the reduction of investment does release considerable cash flow in the short term, it also has to worry about whether the quantity and quality of content will be reduced after the budget is reduced, which is related to the stability of Netflix's content barriers.
In the past year or two, the natural growth of Netflix subscribers has basically been very small, mostly relying on the pull of the season's explosive models. In the first quarter, Netflix cut prices sharply in the Asia-Pacific region, especially the price of the basic version, and the intention behind it was clear - to lower the threshold for customer acquisition in an attempt to increase penetration at the fastest speed.
But Netflix also said that the actual revenue contribution of this part of the user is currently very low. That is to say, the growth of users in these regions cannot play a supporting role in the short term, but relies on the advantages that still exist, first win users, and then cultivate long-term use habits.
Therefore, we don't need to care whether this part of potential users can become a new growth support in the future, but in the short term, Netflix's performance pressure is visible to the naked eye, and its dependence on explosive models is becoming heavier. From the valuation point of view, it is currently in the neutral range, there is no obvious safety cushion, the holding experience in the volatility is poor, and the current participation value is not high.
Specific data of this financial report
First, the account sharing package was boycotted for a short time, and the user's subscription was not as expected
Although Netflix's content library in the first quarter is not weak, for example, the second season of "Ginny & Georgia" climbed the list of the top 10 historical broadcasts, and the 1-3 seasons of "Outer Banks" were sold in March, but the account paid sharing plan was officially launched in Latin America at the beginning of the year, and after expanding to Canada, New Zealand, Portugal, and Spain in early February, it encountered short-term user resistance (sharing accounts between friends, remote login requires additional fees), triggering a "wave of unsubscribe". Instead, it caused the loss of users. As a result, Netflix added 1.75 million users in the first quarter, less than the market expectation of 2.3 million.
Since Netflix plans to expand the promotion of account sharing in the second quarter, such as the United States, it is expected that user growth in the second quarter will still be under pressure, but the market has not taken into account the impact of this, coupled with its relatively weak content library in the second quarter, so it has also led to a relatively large expectation gap. The company expects user growth to be similar to the first quarter, but the market expects a whopping 3.5 million.
However, the good thing is that from the latest March data, the short-term impact of Canada, which was the first to promote this time, is weakening, and the number of users began to return in March.
The effect of ad-supported services in driving user growth is also very average. This is basically consistent with the judgment in Dolphin Jun's last quarter's earnings review, although the ad-supported version can theoretically reach more user groups, but the ad still has an impact on the immersive look and feel of the long video, so like the account sharing plan, the effect of the combination punch is still more dependent on the popular content of the current period.
Although the content in the first quarter was not weak ("Ginny & Georgia S2" and "The Glory S1" were on the top 10 in terms of historical views), it was still inferior compared with the previous quarter with "Wednesday" (Top2), which caused the current pressure period when users were more insensitive to advertising services and more resistant to account sharing.
Dolphin Jun believes that although short-term caution is better, there is no need to be too pessimistic. Generally speaking, Netflix's content output is mainly in the second half of the year, and the first and second quarters have always been off-season, especially the next two quarters. From the perspective of historical trajectory, as long as Netflix can move good content, it will not worry about selling seats.
In terms of regions, the main force of user growth this time is the Asia-Pacific and Europe-Central Africa regions, while the user scale in Latin America did not increase but fell in the first quarter.
1) Users in mature markets such as Asia Pacific and Europe increased by 1.5 million and 600,000 respectively month-on-month;
2) North American users increased by 100,000, Latin American users lost 450,000.
In the medium and long term, the company continues to express confidence in the "migration trend of traditional cable TV to streaming media". According to Nielsen's data, the share of user time spent in US streaming media in the first quarter has indeed further increased, increasing by 1.5pct from December to February last year to 39.6% (including MVOD mode), but the rate of penetration improvement has slowed down to a certain extent.
However, the streaming media penetration rate in Europe, Latin America and other countries is significantly lower than that of the United States, which also indicates that Netflix and other streaming media platforms that are good at content internationalization still have a lot of room for penetration, and the industry still has dividends.
Second, a wide range of price reductions, condescending to low- and middle-income areas
Revenue in the first quarter was $8.16 billion, up 3.7% year-over-year. Due to the high exchange rate of the US dollar, Netflix, which accounts for 60% of international revenue, weakened the actual situation. Excluding currency effects, real revenue increased by 8%.
In terms of segmented business, streaming media revenue (subscription + advertising) was US$8.13 billion, a year-on-year increase of 3.9%, mainly driven by user growth; DVD sales are expected to fall 21 percent, and the company expects to shut down the business completely by the end of the third quarter.
In subscription revenue, single-user payments continued to decline year-on-year in the first quarter, and Dolphin Jun believes that this trend may continue in the short term. On the one hand, the increase in users of ad-supported plans will pull down ARPU; On the other hand, Netflix has implemented significant price cuts in more than 100 countries and regions at the beginning of this year, with the Asia-Pacific region as the main region.
Although Netflix indicated that the regional revenue of the price reduction accounted for less than 5% of the total revenue, it also revealed its intention to increase the activity of users in these regions.
Dolphin Jun believes that the North American market has matured, there is no natural growth, seasonal fluctuations are dominant, and short-term driving basically depends on explosive content.
Therefore, Netflix needs to tap the user penetration rate in non-US regions to tap long-term growth, East Asia, South Asia and other low- and middle-income Asia-Pacific users, at this stage of price increase to do income is not realistic, price reduction is better to do users.
As can be seen in the figure below, the price reduction this time is mainly aimed at the price of the basic version, and the standard version and the high-end version have not changed much, which also shows that the main purpose of Netflix's price reduction is to reduce the threshold for the fastest customer acquisition.
Third, streaming media competition: the industry is at ease, and the erosion outside the industry is continuing
Last quarter, Netflix named the competitive impact of YouTube and TikTok for the first time in its earnings report, although it was not mentioned this time, but from Nielsen's data, YouTube's share is still growing (from 8.7% in December last year to 9.1%), while Disney, HBO and other direct competitors, like Netflix, the overall share is temporarily stable.
Netflix's advantage is still a large and relatively high-quality content reserve, and Disney, Amazon, Apple TV, and HBO still need to make up for the shortcomings for the time being.
Or compare Netflix with Disney, Disney as a catch-up, but the speed of streaming content output is still not as fast as Netflix.
Fourth, the investment cycle is approaching, but this year's quota has been reduced
Content investment expenditure in the first quarter was RMB2.8 billion, continuing to decline from the previous year. Compared with the first quarter of previous years, the amount of investment decreased by 1-1.5 billion. The management revealed in this earnings report that this year's investment budget will be reduced from the original 17 billion, which means that more cash flow will be released.
Dolphin Jun believes that this year's global economy is under pressure to grow due to the high interest rate environment, and the United States is also the first to bear the brunt, and 45% of Netflix's revenue comes from North America. Therefore, based on this consideration, although it is a relatively rational decision to reduce investment in a timely manner, will the sudden braking at the inflection point of the new investment cycle affect the content output in the following 1-2 years? Dolphin Jun is relatively cautious and needs constant observation.
As of the end of the first quarter, Netflix's content assets were 32.35 billion, accelerating a decrease of 390 million from the previous quarter.
2. The content investment expenditure in the first quarter was 2.8 billion, which was less than 17 billion this year. At the same time, content amortization continues to accelerate as supply continues to increase, and the accelerated dematerialization of content reserves will bring the inflection point of the input cycle closer to the end.
3. As of the end of the fourth quarter (the first quarter results report is not disclosed), Netflix's self-made content accounted for more than 60%, but the scale of self-made content assets has turned negative month-on-month. Based on the further decline in overall content assets in the first quarter, it is expected that self-made content may continue to decline, and the demand for content replenishment is on the line.
Fifth, refrain from marketing, profit exceeds expectations
The first quarter is not the peak season for content, and the cost and expense are small, so Netflix's profitability will recover significantly from the fourth quarter of the previous year. Despite pressure on first-quarter revenue, marketing expenses were less than expected, resulting in a 1pct higher operating margin (21% actual vs. 20% expected vs. 20% guidance).
However, due to the greater pressure on second-quarter revenue, the company's operating margin guidance of 19% for the second quarter was weaker than the expected 21%.
The full-year 2023 operating margin target remains in the 18-20% range (at the January 1, 2023 exchange rate), which, combined with short-term revenue pressure, means that there will be more action to reduce costs and increase efficiency this year.