Netflix Earnings Review: Margins Drop to 24.5% After $80B Deal—Is the Risk Now Priced In?
$Netflix(NFLX)$
Key Financial Highlights
-In the fourth quarter, Netflix reported revenue of $12.05 billion, up 18% year over year. Operating income reached $3.0 billion, translating to an operating margin of 24.5%, while diluted earnings per share came in at $0.56.
-For full-year 2025, revenue totaled $45.0 billion (+16%), with an operating margin of 29.5% and free cash flow of $9.5 billion.
-Looking ahead to 2026, management guided for full-year revenue of $50.7–$51.7 billion, a target operating margin of 31.5%, and free cash flow of approximately $11 billion.
Earnings Beat Driven by Content Strength and Operating Leverage
The earnings outperformance was primarily driven by a virtuous cycle between improved content quality and rising engagement. Netflix disclosed that total viewing hours in the second half of 2025 reached 96 billion hours, up 2% year over year, with viewing of original content increasing 9%, serving as the main growth engine. A strong slate of originals, such as the final season of Stranger Things, boosted retention and word-of-mouth, supporting membership growth and pricing power despite unfavorable foreign exchange movements.
These trends translated directly into the top line. Fourth-quarter revenue grew 18% year over year, exceeding company guidance by roughly 1%, driven by stronger-than-expected membership growth, ongoing price increases and higher advertising revenue. Operating leverage further lifted full-year operating margin to 29.5% and supported free cash flow of $9.5 billion in 2025, providing a solid foundation for future capital allocation.
Advertising Business: User Scale Established, Long-Term Upside Clear
Advertising continues to strengthen Netflix's medium- to long-term growth narrative. The company reported that advertising revenue grew more than 2.5x year over year in 2025, surpassing $1.5 billion for the first time. More importantly, the ad-supported tier has reached a scale that supports sustainable monetization.
As of October–November 2025, Netflix disclosed that monthly active viewers on the ad-supported tier approached 190 million, indicating that the ad tier now reaches a near “hundreds-of-millions” audience globally, offering advertisers stable and meaningful reach. Third-party data also show that ad-supported viewing penetration in U.S. households rose to approximately 45% in 2025, suggesting that advertising has not materially undermined user experience.
Management further guided that advertising revenue could roughly double in 2026 versus 2025. Combined with continued investment in Netflix's proprietary ad technology stack, this positions advertising to improve cash yield per hour of engagement. While advertising remains a relatively small share of total revenue today, its strategic value in enhancing subscription resilience and improving long-term cash flow quality is becoming increasingly evident.
M&A Impact: Margin Pressure Emerges as Financing Costs Begin to Flow Through
Acquisition-related effects have begun to surface in Netflix's quarterly margin profile. Fourth-quarter operating margin declined to 24.5%, down from 28.2% in Q3 2025. While part of the sequential decline reflects content amortization timing and seasonality, financing costs tied to the proposed acquisition are becoming a more important factor.
Netflix disclosed that fourth-quarter net income included approximately $60 million of interest expense related to bridge financing and associated reductions tied to the proposed all-cash acquisition of Warner Bros. Although the transaction has not yet closed, financing activities are already underway, and changes to the capital structure are starting to have a marginal impact on profitability. This helps explain why investors became more sensitive to near-term earnings pressure following the report.
From a cash flow perspective, an all-cash transaction of roughly $80 billion would materially increase leverage, but does not represent a systemic cash flow risk. As of year-end 2025, Netflix held approximately $9.0 billion in cash and cash equivalents, generated $9.5 billion in free cash flow in 2025, and expects around $11 billion in 2026—providing capacity to gradually absorb debt, refinance bridge loans and manage higher interest costs.
Over the longer term, the addition of Warner Bros. and HBO Max would significantly expand Netflix's portfolio of premium content and IP, with potential benefits for content monetization efficiency, advertising pricing power and cash flow stability. That said, until transaction execution and the regulatory pathway become clearer, margins and valuation are likely to remain under near-term pressure.
Conclusion
Overall, Netflix's fundamentals remain on an upward trajectory, supported by improving engagement, a maturing advertising business and strong free cash flow generation. However, the proposed ~$80 billion all-cash acquisition has begun to weigh on margins through financing costs, and near-term share price movements are likely to be driven by regulatory, financing and execution uncertainty.
Against this backdrop, from a fundamental and cash flow perspective, the current share price around $87 appears to reflect a risk discount tied to acquisition uncertainty rather than a rejection of Netflix's long-term business model. With the ability to generate more than $10 billion in annual free cash flow, Netflix has the capacity to gradually absorb acquisition-related financing and repair margins over time. While the stock is not a clear, low-risk bargain at this level, it has entered a range that may be suitable for long-term investors to build positions incrementally.
Separately, a previously published options activity analysis suggested that the options market has been pricing Netflix in a $100–$110 medium-term range, reflecting more optimistic expectations among some market participants. Certain sell-side analysts argue that even under a conservative acquisition scenario, the assets involved could deliver modest earnings accretion over the medium term. More importantly, Warner Bros.' extensive content library could help Netflix reinforce user engagement in mature markets while expanding its subscriber base internationally. Last week, HSBC analyst Mohammed Khallouf initiated coverage on Netflix with a Buy rating and a $118 price target.
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