Roughly $175 a share. That’s where Netflix bottomed in June 2022, despite having entered 2020 at a much higher level of about $325 a share before the world stayed home and streamed. There are enough sob stories among Netflix investors to justify one of its excellent documentaries. Move aside Drive to Survive, it’s time for Trade While Afraid.
Yet here we are, with a recent 52-week high for Netflix of $485 as exuberance found the US market once more in 2023. The Nasdaq-100 index is up 42% this year vs the S&P 500’s 19% gain. Tech is back with a vengeance, thanks to all the hype around artificial intelligence (AI). That’s the only kind of intelligence that buys some of the stocks at these valuations.
The market is hot, which puts us back into a potentially dangerous situation of musical chairs. We’ve been there before and we will get there again many times. Eventually, there’s a big correction and market volatility sorts itself out, with fortunes made and lost along the way.
The market is hot, which puts us back into a potentially dangerous situation of musical chairs
I wrote recently about a potential double top at Microsoft and how I was debating whether to take money off the table. I trimmed my position in the end, though the price is still doing well despite the risks. As an aside, Microsoft is a ten-bagger (giving a 10 times return) over the past decade. Though it is a solid long-term choice, the AI hype in the valuation is difficult to ignore and creates significant risk of short-term underperformance at this share price. Of course, the other risk is being too cute with position timing and missing another leg-up. This game isn’t easy.
Netflix is also a ten-bagger over the same period, though it was practically a start-up a decade ago whereas Microsoft was already one of the world’s most valuable companies. The most impressive thing about Microsoft is the extent of growth off such a large base.
The world’s favourite streaming platform just released its second-quarter results. The shareholder letter kicks off with an update on the password-sharing crackdown, which seems to be going well. I recently caved on getting a DStv streaming package (just before the All Blacks game — sigh) based on the inability to share a subscription with someone for occasional viewing.
Netflix is taking a different approach, actively encouraging paid sharing rather than trying to prevent any sharing at all. The idea is to make it as simple as possible to add other users to an existing package, which is also a clever way to juice up a metric that most tech companies would call average revenue per user. Netflix calls this average revenue per membership (ARM), as there are many more users than there are members.
In each region where this has been launched (and there are more than 100 of them, representing 80% of group revenue), sign-ups are exceeding cancellations. This sounds like total sign-ups, not just sign-ups driven by the crackdown. Either way, Netflix is still growing despite the efforts to stop different households using the same Netflix account, so that has given some support to the investment story.
The strong dollar isn’t helpful to a global tech business like Netflix
The trouble is that though revenue is growing, it isn’t growing by much. Revenue is only up 2.7% year on year in dollars, despite 8% growth in memberships. The strong dollar isn’t helpful to a global tech business like Netflix. ARM is also under pressure because of few or no pricing increases in the largest markets in the past 18 months, a response to consumer spending constraints in many regions and an important way that Netflix avoided upsetting people before the password crackdown. Netflix’s advertising efforts also aren’t moving the dial at the moment for ARM, as they can’t even offset the impact of not having pricing increases.
Forecast revenue growth for Q3 is 7% on both a reported and constant currency basis. This is important, as we are now lapping periods of dollar strength. That still doesn’t help the problem of a structurally strong dollar, with Netflix trying to manage a US cost base with international revenue.
Q2 operating margin of 22.3% was the highest seen in the past year and free cash flow approximated net income, which is unusually good for Netflix. The goal is a full-year operating margin of 18%-20%, so this was a particularly good quarter for profitability.
Alas, the market wants growth rather than profits, so the share price fell 12.5% in the aftermath of results.
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