Netflix May Have Beat Expectations, But It Also May Have Missed The Point

Summary:

• Recently, it has begun to look like Netflix experienced a turnaround from the rocky position it entered at the start of the year.
• It wasn’t just “one” thing that helped with the about face, more so a collection of steps that eventually resulted in a positive earnings period.
• Although despite the recent strong reporting, one can still get the sense it might be too soon to fear the worst is over and we’re back to smooth streaming.
• While Netflix is adding an ad tier, cutting spending and working with theaters, each of those approaches carry question marks – chief among them if they will actually help long term.
• For example, Netflix already teased ramping up spending (again) and pulling back on its new theatrical alliance. Some also question if the ad tier will prompt subscribers to downgrade plans.

It has become a self-fulfilling prophecy that streaming has turned into the Wild West. And that’s not just with reporting in data, but with changing trends and taste… anything truly does go in this brave new digital world.

As a result, we see a lot of ebb and flow in results – something Netflix (NASDAQ:NFLX) experienced throughout 2022. You would think that after the train went completely off the tracks, the streamer would be a little more cautious following a change of earnings pace for the positive.

You would think that… wouldn’t you?

And yet since posting its first positive earnings in some time Netflix made a series of baffling moves that leads to the question of it missed the point all along.

First, as always, some background.

I don’t need to recount the highs and mostly lows of Netflix this year. The company had a string of bad numbers come in as it lost a ton of subscribers after seeing strong pandemic-induced gains.

Following that, Netflix hit pause on spending, laid off employees and switched gears on a few policies it said it would never budge on (including adding an ad tier). That combination seemingly worked and helped course-correct what had been a shocking decline for the leader in the space… leading to some analysts to believe it had weathered the storm.

As long-time investors likely noticed, it wasn’t just “one” thing that helped with the turnaround. More so it was Netflix recognizing it needed to take a number of key steps, and the fruits of that labor resulted in a positive earning period.

So naturally the next step is to go right back to what wasn’t working… right?

While I’m being sarcastic that seems to be where Netflix is headed.

The company is essentially sending signals that the worst is behind it and they’re going to go right back to business as usual.

I understand the excitement and how they’re looking to capitalize, but I wonder if these changes are happening a little early. In some ways it seems like a “those who forget the past are doomed to repeat it” type of scenario in the making.

It started with a comment that Netflix would look to ramp back up its spending for new content and then it continued with an even more surprising claim that riled up its partners.

You’ll remember Netflix recently cut a deal with various theater chains to give its Knives Out sequel an exclusive sneak preview run before it came to the service. The twist was that while the film would only screen for a week around Thanksgiving, it would then be vaulted until its premiere around Christmas.

This was Netflix’s workaround to its insistence on “day-and-date” titles that have long put them at odds with exhibitors… something I dug deeper into last month. At the time the move was praised… and instead of attacking Netflix, the various chains were riding high on its cooperative spirit and hopes for this being a sign of things to come.

It didn’t last long.

Ted Sarandos during the most recent earning report appeared to throw cold water on the theory that this was going to be something we often see duplicated. While investors weren’t expecting this to be the way for every release, the hope had been this could be the case for its top tier films.

Now though it seems to be a one-and-done.

There are all kinds of debates all the time, back and forth. But there’s no question internally that we make our movies for our members, and we really want them to watch them on Netflix. And, of course, with one week of release in theaters, most people will see them on Netflix. Just like they see all movies. Most people watch most movies at home.” – Ted Sarandos

It’s a stunning about face and one that’s not sitting well with industry insiders. While AMC refused comment requests from multiple trades, a few sources went off the record including ones who told The Hollywood Reporter this felt like Sarandos was “retreating” and “undermining his own team.” Others astutely called out that if Netflix really didn’t care about the theatrical impact, why pick a busy weekend like Thanksgiving?

There’s also recent comments by IMAX (NYSE:IMAX) head Richard Gelfond and Warner Bros. Discovery (NYSE:WBD) topper David Zaslav and that speak to their belief in the traditional theatrical model and its economic returns.

I’ve seen the data… A movie that opens in theaters perform five times as well as when it goes directly to streaming. The economic return when you open something in the theater.” – David Zaslav

I’ve always been on the side that believes working in a symbiotic relationship with theaters was a necessary part of the plan for Netflix to sustain profitability. Pre-COVID it was a big thing holding them back on a few levels. Although I really shouldn’t be surprised by the about-face and neither should investors.

Netflix’s core subscribers are a die-hard group that like their trademark “all-at-once”/”day-and-date” model, and when the streamer tries to change that – it doesn’t tend to go well. My favorite example is from a few years back when Netflix switched some of its reality shows from all-at-once to a gradual roll-out… just a short while later it rushed to clarify this was a one-time deal.

The weekly release of licensed titles (like Great British Baking Show) isn’t new and in hopes of keeping Rhythm + Flow’s winner a surprise, we’re trying something new! but not happening with more shows than that.” – Netflix

The vocal minority always has been impacting their judgment and at this point Netflix really can’t afford to let that happen any longer.

Adding an ad tier, working with theaters, changing their distribution model and pursuing live events are all things Netflix should be doing, but what we’re seeing is none of these were priorities until it was forced to in order to survive.

These choices were not made proactively, all were reactive and at one time all were things Netflix’s team were adamant would never happen.

Funny how that works right?

Ramping up spending is what got Netflix into this mess and I believe not working with theaters has been very costly in the long run (though they’d never admit it). Changing positions on both after one positive earning period doesn’t make sense to me – especially since many are questioning if the ad tier model that they have put so much into will end up hurting them down the road.

Yes, the ad tier option was needed but questions linger about if that will entice current subscribers to downgrade their plans. In other words, yes subscriber counts will be steady, but revenue will be down. You also have those who are going to cancel out of frustration over the password sharing crackdown and some reporters going as far to show users exactly how to change their plans in general.

And then there’s the reaction from creatives – Bridgerton and Finding Anna‘s Shonda Rhimes has been among those very vocal about the shift. She signed her Netflix deal under the assumption her shows would be seen without ad breaks as she intended when she created them.

Similar feedback has come from the team behind The Haunting Of Hill House which has said the ads break-up the tension that builds during the scene… a staple of horror programming.

Also Netflix isn’t cutting these creators into the profits for ad tier revenue – that isn’t helping anything.

It just seems like a lot of these steps were done to plug holes, but the plug isn’t big enough and the water is building up. Yes, it may be sturdier than before, but it’s not on solid footing – and it doesn’t help Netflix may get more selective with its shared earnings metrics.

The streamer may indeed be back on the road to recovery but it could just as easily relapse and investors should be cautious for the time being.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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