Netflix earnings call: Monetizing shared passwords; moving toward advertising (updated)
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Netflix (NASDAQ:NFLX) may have beaten profit expectations, but with competition hot in the high-stakes streaming media space, investors' eyes are firmly locked on subscriber numbers and what it means for companies' growth trajectories.
The big worry before was that Netflix might miss even the lowered expectations for growth of 2.5 million net subscribers in Q1. The actual number, a decline of 200,000 subscribers, coupled with a forecast that it would shed 2 million more subscribers in the second quarter, came as especially cold water for investors in Netflix as well as other companies banking on the streaming economy.
Shares were 26% lower postmarket Tuesday at the release of the company's earnings executive interview, in which J.P. Morgan's Doug Anmuth delivered questions (including investor submissions) to Netflix's key executives. The stock's drop was similar to the last time Netflix was in this situation.
Netflix acknowledged growth wasn't what it wanted. It pegged the decline to four "inter-related" factors: Pace of growth into broadband homes is partly dependent on factors out of its control; competition has ramped up heavily in the past three years; macro factors (economy, inflation, Russia's invasion of Ukraine); and notably, unpaid password sharing - a concern that execs used to blow off as not especially relevant.
So the surprising line from the investor letter was "We estimate that Netflix is being shared with over 100 million additional households, including over 30 million in the UCAN [U.S and Canada] region" - an especially large and shocking number against the company's 221.6 million total global paid subscribers.
Anmuth brought up the more sober tone of the investor letter up front. "Our views are a little different because our numbers are a little different," co-CEO Reed Hastings notes.
Account sharing isn't new, he says. "But when you add that up together, we're getting pretty high market penetration and that combined with the competition is really what we think is driving the lower acquisition and lower growth."
As for monetizing that sharing, "when we were growing fast it wasn't a high priority to work on. And now we're working super hard on it," Hastings says.
One other factor of note when it comes to elevated user churn this quarter was the most recent price increase, hitting its home U.S. and Canada market.
The increases Netflix is making in various markets are "significantly revenue accretive," says Chief Operating Officer/Chief Product Officer Greg Peters. "The vast majority of our members recognize that we are investing ... what they pay us ... into more entertainment value back to them, back to our members, more great stories, bigger films, more variety of content, and higher quality of programming."
As for increasing the "pipe spread" with advertising on lower-priced plans, Hastings notes people know he's been against it. "I'm a big fan of the simplicity of subscription. But as much as I'm a fan of that, I'm a bigger fan of consumer choice, and allowing consumers who would like to have a lower price and are advertising-tolerant, to get what they want, makes a lot of sense." The company will try to figure that out over the next year or two, he says, but "think of us as quite open to offering even lower prices with advertising."
An ad-supported plan (now sounding increasing like a probability rather than a possibility) would phase in over a couple of years in terms of volume and profit potential, Hastings says. Asked about whether that would test in a few small markets, he says other companies are figuring it out (Hulu, Disney, HBO) and "I'm sure we'll just get in and figure it out." It would come in "as a layer," Hastings says, so those who want an ad-free option will still have that consumer choice.
Pressed on whether the company might rethink $18 billion in cash content spending in a slower sub-growth era, co-CEO Ted Sarandos says "Look, I think we have to continue to invest in the content, both in the quality and the variety ... we will continue to grow the content spend relative to prior years ... we're very focused on making sure that the impact of the slate continues to grow." CFO Spence Neumann adds, though, that its pledge of holding operating margin steady for the next 18-24 months "does mean that we're pulling back in some of our standard growth across both content and non-content spend - but still growing our spend."
Games are still a "top-level priority," Peters says. Netflix is open to games around owned or licensed intellectual property, but "you can see an early glimmer of where we're trying to head with this" with the company's new first-of-its-kind deal to produce both a game and an animated series based on the physical card game Exploding Kittens.
The Q1 call is in the books, and at 7:15 p.m., Netflix (NFLX) is 26% lower postmarket. Taking into account the last two earnings disappointments, Netflix's current after-hours price is down 60% over the past six months, and it's 63% below the 52-week high of $700.99 hit on Nov. 17.
See the transcript of the Netflix executive interview.