Netflix Stock Faces Near-Term Challenges, But Bull Thesis Intact (NASDAQ: NFLX)
By the Netflix (NASDAQ:NFLX) 4Q21 Letter to Shareholders, only 2.5 million paid subscriptions are expected to be added in 1Q22, which is still less than the 3.8 million that were added in 1Q21. To put things into perspective, 15.8 million paid subscribers were added in 1Q20. 1Q22 revenue is expected to be $7.9 billion, implying year-over-year growth of just 10.3%. That’s terrible compared to 1Q21 which saw 24.2% year-over-year revenue growth. The operating margin has been growing at around 3% per year and that’s not expected to happen in 2022. My thesis is that Netflix is still a wonderful company despite these indications from the 4Q21 shareholder letter being disappointing.
Exchange [FX] these explanations allay our concerns about operating profit. The 4Q21 letter explains that they are not hedging and that FX moves are expected to be costly in 2022. FX headwinds are expected to reduce 2022 annual operating margin by 2 percentage points:
Image source: 4Q21 letter to shareholders
CFO Neumann makes statements in the 4Q21 call that put the chart above into perspective. He says they are still committed to operating margin growth of 3% over a 2-year period, so they will eventually catch up to the rate of improvement of 3% per year. I think this means we will be close to 25% by the end of 2023:
No, it’s really just FX, Nidhi. So, as we said in the letter, we lost about $1 billion in expected revenue in 22 thanks to FX. It’s about 2 margin points. So if you just look at our guide and add that, we’re on our pace of adding about 3 margin points per year. And I can’t forget that we’ve exceeded our margins for the past two years. So that’s really all that’s going on here. And the FX move really happened in the last 6 months of last year. So what we’ve always said is that we don’t want to flip the company unnecessarily quickly. We want to be able to invest in a healthy way in our growth opportunities. And over time, we’ll then scale our — appropriately our investment levels, our cost structure, our pricing to fit where the currencies come in. And so that gives us a bit of time to do that. So that gives us a little time, but we will catch up. We always commit to around 3 – 3, an average of 3 points of margin increase over a two year period. But there is no change there. We’ve always considered our investment in the content, our investment in the game.
The 4Q21 letter indicates that the FX challenges are costing them approximately $1 billion in expected revenue for 2022. According to CFO Neumann, the expected 10% year-over-year revenue growth for 1Q22 is not not as bad as it looks due to currency concerns and a difficult comparison to 1Q21:
what i would say [is that] Currency-adjusted constant currency for Q1 year-over-year is around 14% growth. It’s also a tough year-over-year comparison in the first quarter, because you may remember that we raised prices in the US. [at the end of] The fourth quarter of 2020, which continued until the first quarter of 21, is when it really materialized. So year-over-year compensation is difficult. So the company’s underlying organic revenue growth is, right now, at least in the first quarter, closer to 15% plus, 16%, 17%.
The world has room for Netflix, Disney+ (NYSE: DIS) and HBO. We’ve seen some pull-forward issues with Netflix subs, but if we look at the combined total for 2020 and 2021, then all is well. Revenues have also grown well for Netflix over this period and operating income growth has been phenomenal as margins have improved. This all happened as Disney+ subscribers skyrocketed and HBO saw some growth; there is plenty of room for all these content providers:
The Netflix paid subscription line above in red is well ahead of the Disney+ paid subscription line in black and both are ahead of the HBO paid subscription line in purple. The difference is even more pronounced when you consider that HBO has a wholesale problem and Disney+ has an average revenue per user. [ARPU] problem.
HBO’s purple line above is apples and oranges, as most of their subs are big. The AT&T 3Q21 Financial and Operational Trends document shows that only 12.6 million of HBO’s 45.2 million domestic subscribers are direct. There are 24.2 million additional international subscribers, bringing HBO’s total subscriber count to 69.4 million for 3Q21. A Jan. 5 release says HBO’s undercount jumped to 73.8 million for 4Q21.
We have to remember that Disney+ has a long way to go to catch up with Netflix in terms of revenue. Indeed, Disney+ has not shown pricing power; their ARPU is lukewarm compared to what we see from Netflix. By mixing geographies, Disney+ ARPU decreases while Netflix ARPU increases:
In recent years, subscriber growth has been good in Asia Pacific [APAC] and Europe, Middle East and Africa [EMEA]. Management said the current Covid overhang and macro headwinds may explain why we haven’t seen much growth in Latin America [LATAM]. I believe that the United States and Canada [UCAN] the market is flat because it is mature:
The 4Q21 call began with Fidelity portfolio manager Nidhi Gupta asking if net additions were below the guidance number and co-CEO Reed Hastings responded by implying that the difference between 8.3 million and 8.5 million is relatively low. Co-CEO Ted Sarandos then added that this estimate was all the closer as it sits at a subscriber level of 222 million. This shows the complexity of making estimates; net additions are based on gross additions minus losses due to churn. CFO Spencer Neumann put the small difference into perspective by noting that it was only about 1/1,000th:
We generated 8.3 million net paid ads. So that was just a bit shy of around 0.1% out of around 222 million paying members.
Being down 200,000 subscribers in 4Q21 wasn’t the end of the world, but the forecast of just 2.5 million net additions for 1Q22 is unfortunate. This means that we could see even fewer net additions in 2022 than in 2021:
My thoughts on valuation have diminished since my January 2021 post as it will take longer than I thought for Netflix to hit 400 million paid subscribers. Still, I thought the stock price drop of more than 20% on Friday was an overreaction.