Why Netflix’s Most Important Earnings Period Is Always Its Next One

Summary:

• Netflix’s recent recovery and stock turnaround came after the company reversed course on a number of “nevers” – such as “never have an ad tier” or “will never cut spending.”
• In addition, Netflix also stopped looking the other way on password sharing, which caused an outcry among viewers and a worry about a “mass exodus” of subscribers.
• So far, the corrective measures have worked and the “exodus” was outweighed by growth – but it would still be wise for investors to take a “wait and see” approach.
• This always has been the case with Netflix as even pre-crash, there was always a concern about the company’s approach facing sustainability questions. It was that level of overall complacency that hurt investors when the stock dipped.
• While the company expects a positive upcoming earnings report, the following quarter’s results will be more indicative of the impact of its changes, as churn remains a constant issue and competition for talent and subscribers intensifies.

For the past few years there’s been a common theme when it comes to Netflix’s (NASDAQ:NFLX) earnings – the current report doesn’t always matter as much as the next one.

While you can make that case for any company, with Netflix it’s different…namely because for so long it bucked any type of normal trajectory, but we knew eventually it had to come back down to Earth.

As a result each period was another installment of “is this the quarter? And after such a long period of time when it “wasn’t the quarter,” Netflix (and its investors) eventually got complacent assuming they had dodged a bullet.

Right on cue, that’s when the bottom fell off.

And yes, it’s hard to blame them for that sense of calm. With the majority of the world trapped in their houses during COVID, it’s no wonder streaming numbers continued to soar for the streamer. Remember at the time Disney (NYSE:DIS), Apple (NASDAQ:AAPL) and WBD’s (NYSE:WBD) services weren’t anywhere near as solid as they are now, meaning Netflix was clearly still the top of the heap.

While the stock did eventually hit the wall it’s re-growth to the top has been steady and many expect that trend to continue with the next round of earnings, but as with all streaming stocks it’s good to have a little reminder of why ones in this sector have lately come with a “buyer beware” warning.

First as always, some background.

Netflix’s turnaround came after the company reversed course on a number of “nevers” – such as “we’ll never have an ad tier,” and “we’ll never cut spending.”

Long story short, they did and both seemed to show signs that those measures would do the trick. Both also led to some hard conversations and decisions by Netflix, but they navigated it as well as can be expected.

Shortly after came the news Netflix was doubling-down on its corrective measures and said they would also finally crackdown on password sharing.

The news went about as well as you’d expect it to.

While many saw the upside, others were hooked on the doom-and-gloom around the idea of a potential mass exodus.

That’s the funny thing about consumers though – they’ll say anything without having to back it up.

It’s easy to get someone to say they are “shocked” and “appalled” by a move, it’s another to get them to act and to do something as a result.

So when Netflix enacted its plan, an equally funny thing happened – the mass exodus never materialized. Instead, new subscriptions rose substantially. In the days following its implementation average daily signups rose 102% over the past 60 days.

That exceeded the growth seen at the start of COVID.

As a result, you can see why everyone is expecting a rosy earnings report next week – and that may happen, but as I said upfront…it’s the NEXT report that will ultimately tell the real story.

What gets glossed over in these “success” stories is that while Netflix did grow over 100% in total new subscriptions – cancellations were also up in that period.

And not by a small amount either.

Cancellations rose 77%.

Yes, that’s still a 25% net growth…but that’s not as low of a number as a vague sentence like “it should be noted that cancellations were also up in the days following the password crackdown,” would have you believe.

The real question is what happens in the next few months.

Why?

According to a BStream study during the first four months of 2023 Netflix lost 13% of viewers in Portugal that is blamed on the password crackdown. Spain also saw a decease to the amount of 1 million subscribers…again based on the new password regulation.

Netflix attributes that to a temporary dip and believes that number will rise when those who lost access will decide to buy their own subscriptions.

Again, that may happen, but it also may not.

So while the great streaming exit didn’t exactly happen the way everyone expected…it still happened.

While not everyone who feigned disbelief with the move said goodbye to Netflix, a good amount actually did…yes, a smaller amount, but still a sizable number.

Investors have to keep in mind that churn is not going anywhere and whether you want to attribute it to password sharing, viewer content preferences changing or increased competition it’s not going to magically stop because Netflix has a good quarter…this time.

It’s also important to note that while Netflix has said it is planning to stop revealing several metrics it used to share, the ad-tier addition will lead to new metrics that for a while it had tried to avoid.

The ad-tier is very much a double-edged sword…on one hand it is seemingly helping with subscriber growth, but on the other its forcing Netflix to effectively show its work. Having something as measurable and quantifiable as an ad view cuts into the streamer’s trademark “fuzzy math.”

From the early days, the platform has consistently changed what counts a “view.”

It’s latest determination comes from a formula of hours viewed divided by runtime which finally takes into account that not Netflix’s shows are the same length.

Not exactly a small thing.

Again though Netflix isn’t doing this because it wants to be more transparent – it has to be.

The competition for talent is just as heavy as it is for subscribers and talent/creatives need some type of tangible proof to use in future negotiations. On top of that the new data that comes from the ad-tier would have exposed some of that “fuzzy math” that sounds good when you take it at face value and don’t ask any questions.

All of this is not to say expect Netflix to fall on its face next week…a lot of the data points to Netflix having a solid quarter. But as we’ve seen before one quarter does not make a company – it can certainly break it – but it can’t make it.

You need to see several consecutive quarters of growth to see what is and isn’t working.

There’s also the “surprise factor” which is what Evercore ISI analyst Mark Mahaney is preaching in his reporting…but again you have to read the fine print. Yes, Mahaney, who has often been critical of Netflix in the past, recently showed some positivity towards the company’s future….however he is also warning people not to get to comfortable.

“If the positive intra-quarter sub trends reported by third-party tracking services are accurate, these expectations appear reasonable…but we would view them as likely limiting the opportunity for upside surprise and increasing the odds of a negative surprise.” – Mark Mahaney

Netflix built itself into a giant over time and it fell apart over time so it stands to reason that re-build is not going to be a super-quick flip of a switch. Just as Wall Street went crazy every time it defied the odds, the same analysts and investors lost their minds when it finally did not.

This quarter will tell us a lot about how Netflix’s changes have impacted the company, but next quarter’s results will be even more telling. Not just because it’s a fresh quarter, but because the changes they made going into this one will have had more time to take effect.

In this case that’s no minor element as this is a key part of the company’s continuing quest to regain its footing. Just because “it looks” like it may be on the right track, the past has taught us this type of data takes time to properly analyze.

Think of it as a prolonged period of buffering – but one that will ultimately paint a clear picture for both this company and the sector overall.

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