Why Netflix Plunged 5%?

Event

$Netflix(NFLX)$ plunged 5%+ on Wednesday, due to the CFO providing relatively negative guidance at the Bank of America Media, Communications, and Entertainment Summit.

He believes that the company's advertising business will not have a significant impact on the company in the short term and announced an operating profit margin guidance of 18-20%, which is lower than the market's consensus expectation of 22%.

The market's high expectations for profit margins are mainly based on the anticipation of a high-margin advertising business, indicating that Netflix's advertising business may be constrained by certain factors.

Investment Highlights

Revenue is still growing positively, but the growth expectation for ARPU should not be too high.

The market expects Q3 ARPU YOY growth to be 6.74%, reaching $11.7, while Netflix's ARPU for the previous five quarters, including Q2, showed negative growth.

By regions, EMEA (Q2 YoY -2.69%) and Asia-Pacific (Q2 YoY -13.25%) are the main contributors to this, with Europe being affected by Russia and Ukraine but more significantly impacted by exchange rates (strengthening of the US dollar). In the Asia-Pacific region, besides the exchange rate headwinds, the lower pricing in India and Southeast Asia has become the primary area for subscription growth, lowering the overall ARPU.

Looking at the exchange rate situation in Q3, regions outside the United States continue to face pressure, and this year, due to the Hollywood writers' strike, content production in Q3 is somewhat lower, which may lead to a higher proportion of international growth, thereby lowering overall ARPU.

Conflict between the advertising business and subscription packages

The CFO mentioned during the conference that since implementing stronger password-sharing controls, many users have unsubscribed instead of participating. It is estimated that about 100 million people were previously watching using shared accounts. After these subscription users, who can no longer use shared accounts, tend to opt for ad-free versions of packages, even though they are priced higher, it is not ideal for building the advertising business.

Previously, it was mentioned that Netflix's advertising uses CPM pricing, which charges based on every thousand impressions. Initially, it was priced at $65, but later reduced to $55, still higher than Disney+'s $50 and other competitors. However, if users all choose not to subscribe to the ad-supported version, then ad revenue cannot be generated. Therefore, for Netflix, it is necessary to expand the coverage of the advertising business.

Adjusting Guidance for "Expectation Management"?

We know that for industry-leading large companies, their valuation is more about self-comparison. Therefore, the management of market expectations by large companies largely determines the sentiment in the secondary market.

Netflix management has proactively chosen to "take a step back" because, in the end, if the financial reports come out "below expectations" and shock the market, it's better to proactively lower the guidance beforehand. Analysts should adjust their estimates accordingly.

The result is that investment banks may adjust their performance expectations for this year, but they will still maintain corresponding ratings and target prices.

After all, for Netflix, the advertising business has just started, and there are also some big IP games in the pipeline, which still hold promise in the medium to long term.

For Q3, revenue and profit indicators may be adjusted downward a bit, but due to the strike event, content investment will decrease, leading to an increase in the company's free cash flow. If the strike is not long-term, a decrease in content for a quarter or two won't pose any fundamental issues.

Currently, the market consensus expects Netflix's EBITDA for 2024 to be $9.38 billion, which, in terms of profit multiples, is roughly less than 20 times.