To The Moon

$Netflix(NFLX)$ was the BIG-TECH to release its Q3 earnings on October 18th

Summary

1. New subscriptions surged by 8.76 million under the dual policies of "cracking down on shared accounts" and "budget plans with ads," second only to the global popularity of "Squid Game" during the pandemic period.

2. Reasons for the weakening ARPU include: the possibility that advertising growth may not be as high as market forecasts (previously hinted at by the CEO in interviews and managed expectations), the continued strength of the U.S. dollar, and lower ARPU in regions with high overseas growth.

3. Despite the impact of price increases, advertising, and writer strikes, free cash flow continues to reach new highs (a more important metric for Netflix than profits).

4. Optimistic Q4 performance guidance, with price increases in key markets immediately improving profit margins and free cash flow, while buybacks can also boost optimism in the secondary market.

5. Either more people subscribe to plans with ads, increasing ad revenue (CPM model), or choose higher-priced standard plans, both of which can boost ARPU and margin profit. Fueled by this optimistic guidance, Netflix rose more than 12% in after-hours trading, erasing the losses of the past month.

Q3 Earnings Review

Subs

Global streaming paid subscribers reached 247 million, up 11% year-on-year, with new added 8.76 million subscribers, significantly beat Wall Street's expected 6.2 million, marking the second-best growth rate since the pandemic (the best was in 2020 Q2, the "stay-at-home" season), with continuous growth for five consecutive quarters.

Among these, the US and Canada added 1.75 million, EMEA added3.95 million, Latin America increased 1.18 million, and Asia-Pacific region added 1.88 million.

Revenue reached $8.54 billion, a 7.8% year-on-year increase, slightly below the market's expected $8.3 billion. The company optimized its cost expenses, raising the gross profit margin from 41.1% in Q1 to 42.9%, and the operating profit margin from 21% in Q1 to 22.3%.

Operating profit was $1.92 billion, up 25% year-on-year, with a profit margin of 22.4%, slightly surpassing the market's expected 22.1%, rising 3 percentage points from the same period last year. Net profit was $1.677 billion, and diluted EPS was $3.73, surpassing the expected $3.49.

Cash for operating activities amounted to $1.992 billion, exceeding the expected $1.277 billion; free cash flow reached a historic high, rising from $1.339 billion in Q2 to $1.888 billion.

In Q3, they repurchased $25 billion and plan to increase the repurchase amount to $100 billion.

Guidance

No specific numbers were provided for subscription users, but with such significant growth in Q3, market expectations will be raised. The company had previously downplayed the significance of this number, and the market has gradually become desensitized. However, occasionally providing a stimulus seems to yield good results.

At the same time, the company expects Q4 revenue to grow 11% year-on-year to $8.69 billion, slightly below the market's expected $8.76 billion. The operating profit margin is projected to be 13.3%, below the market estimate of 14%, and the diluted EPS is expected to be $2.15.

Additionally, Netflix has increased the full-year operating profit margin to 20% and raised the full-year free cash flow guidance to $6.5 billion, surpassing the previous estimate of $5 billion and significantly exceeding the market's expected $5.27 billion.

Investment Highlights

First, subscription users continue to benefit from shared accounts beyond expectations.

If Q2 was just the beginning, then Q3 is the harvest season. As we mentioned earlier, while limiting account sharing might lead to some users resisting unsubscribing, the introduction of ad-supported low-cost packages is also suitable for more American middle-class and lower-income families struggling with inflation.

Second, the expectations for advertising revenue have been lowered, but Netflix's response is a "win-win."

The CEO stated in a September interview that the growth of ad-supported subscription users may not be as strong as expected. However, Q3 has shown a 70% increase compared to the previous period, perhaps exceeding the earlier set targets.

So, it seems that Netflix's management has recognized that the price difference between the "standard package" and the "ad-supported package" has not yet been fully realized. Therefore, they continue to raise the price of the standard package, encouraging more price-sensitive users to choose the ad-supported package.

After all, Netflix has not yet separated its advertising business for classification, and no one can accurately model Netflix's advertising business model, so there is no "expectation management." Growth trend.

More users choosing low-cost packages will, to some extent, lead to an overall decline in ARPU. However, don't forget that Netflix's advertising, like other media, is CPM-based, and its pricing is even higher than Disney+ $Walt Disney(DIS)$ . So, as long as the number of ad-supported users increases, advertising revenue can gradually increase, boosting ARPU.

On the other hand, raising the price of the standard package also indirectly raises the ARPU in that region. So, regardless of which package users choose, Netflix can increase its cash flow.

As for the decline in ARPU, factors such as exchange rates and faster growth in regions with low overseas ARPU are even more important.

Third, a significant increase in cash flow is attributed to various reasons.

In addition to the increase in subscription users, price hikes for standard packages, increased advertising revenue, and improved operational efficiency, the major Hollywood screenwriter and actor strike in Q3 is also a significant factor. Although it may be detrimental to ongoing content creation and subsequently affect subscription stickiness in the next few quarters, the content spending in Q3 has significantly reduced.

Since this strike is not only aimed at Netflix, in the context of the entire industry being affected, Netflix is unlikely to lose market share. Therefore, Netflix can continue to retain more cash flow even as content spending declines.

Valuation

Netflix's stock price has been in retreat since September, with the market citing "weaker than expected" advertising monetization and the overall macroeconomic impact of rising US bond yields as excessive valuation on growth stocks. Therefore, the 12% increase after the financial report is considered a retaliatory rebound.

In terms of valuation, after the Q3 financial report, profit margins have been continuously improving, and they may continue to rise. However, Netflix's price-to-earnings ratio for the past 12 months has dropped to around 33x, a significant improvement from the previous quarter. At the current price, the price-to-earnings ratio for the fiscal year 2024 may reach around 22x.

Therefore, with the improvement in profit margins and cash flow levels, Netflix's valuation potential has once again been opened up.