Netflix shares close-up and the company's prospects for investment

Netflix (NFLX) beat expectations in the first quarter, reaching 270 million members.

From a shareholder letter: “With the average household having more than two people, we reach more than half a billion people. No entertainment company has ever created programs of this scale and with such ambition before.”

This global reach, combined with a constant focus on content, personalized recommendations and the creation of passionate fans, creates the ultimate engagement machine.

Netflix (NFLX) shares fell after its quarterly earnings after announcing that  Netflix would no longer report new user growth for the year.

So how does Netflix keep the competition at bay?

1. Netflix Q1 FY24

Netflix's revenue growth depends on two main factors:

👨‍👩‍👧‍👦 Paid Membership: The total number of users paying for the service.

💵 ARM (Average Membership Revenue): How much revenue they generate per subscriber.

Starting in 2025, Netflix will stop sharing memberships and ARM and will focus on revenue and operating margin as key measures of success. New initiatives such as tiered pricing, bans on password sharing and advertising are making subscriber numbers less indicative of a company's performance.

This management team prides itself on transparency, so hiding key metrics undermines the message. However, we will still receive additional engagement data, such as a weekly top 10 or semi-annual report on the most popular games.

Membership increase:

Starting in May 2023, Netflix is ​​cracking down on password sharing in the US and some countries in Europe, the Middle East and Africa. This led to a sharp increase in the number of new registrations.

• 270 million paid memberships at the end of the first quarter of FY24.
• Q1 added 9 million (~5 million hits) and +16% year over year.
• This growth was driven in part by its ad-supported plan and recent efforts to limit password sharing.
• North America now accounts for 31% of Netflix's membership, up from 45% five years ago. This demonstrates the success of their international expansion. Growth in the first quarter was strongest in Asia Pacific (+20% YoY) and EMEA (+19% YoY).

ARM growth

• ARMs were up 1% year over year, or 4% on a constant currency basis.
• The reason for this growth was the October rise in prices in the USA, France and Great Britain.
• Although price increases typically temporarily increase customer churn, the negative reaction is usually short-lived. Judging by the addition of nearly 3 million new members in North America over the last two quarters, the price increase was quickly digested.

Certificate of income:

• Revenue: +15% y/y to $9.4 billion (exceeding the level by $0.1 billion).
• Operating margin: 28% (+7 pp YoY) (2 pp increase).
• Earnings per share (EPS): $5.28 (up $0.76).

Cash flow:

• Operating cash flow: $2.2 billion (margin 24%, -3pp y/y).
• Free cash flow: $2.1 billion (margin 23%, -3pp y/y).

Balance:

• Cash and short-term investments: US$7.0 billion.
• Debt: $14.0 billion.

Recommendations for Q2 FY24:

• Revenue: +16% YoY (or +21% YoY in constant currency).
• Operating margin: 27% (+4pp y/y).

So what to do with all this?

• Revenue and profit exceeded forecasts. Revenue grew +18% in constant currency, accelerating for the fourth consecutive quarter. Paid membership has become the main driver.
• Netflix's guidance for the second quarter of FY24 shows further acceleration, with revenue growth forecast at 21% year over year in constant currency.
• However, the forecast for FY23 is only 13-15% growth. Management expects growth to slow in the second half of the year. Paid exchange began in the second quarter of 2023 in the US, complicating the second half of the year.
• Operating margin guidance was raised to 25% (from 24% previously), implying further margin expansion. Netflix has a very scalable business model with no ceiling on profitability in the short term.
• Free cash flow in the first quarter of FY24 was $2.1 billion. Management continues to expect $6.0 billion of free cash flow in FY24 and cash carrying costs of $17 billion.
• Management repurchased $2.0 billion of Netflix stock in the first quarter, down slightly from $2.5 billion in the fourth quarter of fiscal 2023.

2. Latest developments in business

Let's look at the initiatives that are making a difference.

🏎️From documentaries to live sports,
Netflix has repeatedly pushed back against live sports broadcasts to focus on timeless content such as drama and sports-related storylines. Documentary series such as Formula 1: Drive to Survive have proven to be very effective. 

Lately, management has changed by embracing live events as a way to increase engagement. For example:

Netflix Cup (2023): A crossover golf competition between Formula 1 drivers and professional golfers.

Netflix Slam (2024): An exhibition tennis match between Nadal and Alcaraz.

Jake Paul vs Mike Tyson (2024): Upcoming exhibition boxing match.

WWE Raw (2025): Netflix's 10-year, $5 billion deal will take over WWE's weekly show Monday Night Raw next year.

A new emphasis on live content to create cultural moments is at its dawn. However, if successful, it could become a significant growth driver.

🎮Netflix games are gaining momentum
Starting November 2021, Netflix subscribers can download exclusive games for free on the App Store. This initiative is led by Mike Verdu (former EA and Facebook executive).

🧨GTA Drives Growth : In December, Netflix launched its biggest games yet with a mobile port of GTA The Trilogy - The Definitive Edition, which includes GTA 3, GTA Vice City and GTA San Andreas.

📱 Expanding Catalog: Netflix has recently added high-profile titles like Football Manager 2024 (SEGA) and Farming Simulator 23 (GIANTS Software), as well as an exclusive iOS port of Hades (Supergiant Games).

Since all of these games are provided at no additional cost, the number of downloads is the main indicator of success. Appfigures estimates:

To date, GTA San Andreas has reached approximately 12 million downloads (5 million in the first quarter of 2024).

Football Manager 24 has surpassed 5 million downloads (2 million in Q1 2024)

Hades reached 251K downloads on iOS in less than two weeks.

More than a GTA story: GTA The Trilogy alone was downloaded 11 million times in the fourth quarter of 2023 and 7 million in the first quarter of 2024. Excluding GTA, downloads are up nearly 80% year-over-year as the catalog expands.

Monetization Ahead: The Wall Street Journal reported that Netflix is ​​exploring the possibility of monetizing games through in-app purchases or advertising. Mobile gaming is a rich market expected to reach $111 billion in 2024, as discussed in our console wars coverage.

Big games? A vacancy for a game director for a high-budget computer game was spotted on Netflix. The company has reportedly spent about $1 billion acquiring game studios and investing in its gaming business.

Games have a much higher revenue cap per paying user. That way, Netflix won't have to convert a significant portion of its 270 million subscribers to see meaningful results.

🔒Netflix's secret weapon: long-time subscribers
Streaming services know a simple truth: the longer you're here, the less likely you are to leave. Antenna's recent analysis confirms this, showing that churn rates (the percentage of people who cancel their subscriptions) drop significantly after the first year.

For premium SVOD (subscription video on demand) services, churn drops from nearly 9% in the first year to just 4% in the second year and beyond.

This "ownership advantage" is where Netflix really shines. Just like streaming OG, most of its users have been loyal customers for over four years. This results in an impressively low monthly churn rate of 2%, which is significantly better than the industry average of 5.5% (as estimated by Antenna).

📺The level of advertising is increasing.
Netflix launched its ad-supported plan in November 2023 with 5 minutes of advertising per hour. The $6.99 per month plan generates more revenue than the standard $15.49 per month plan in the US, thanks to ad revenue that more than makes up for the lower price.

So, how are you doing?

• Ads membership grew 65% QoQ (following two quarters of ~70% QoQ growth).
• The advertising plan already accounts for 40% of registrations in available markets.
• Monetization continues to lag as management ramps up sales capabilities. So the earnings growth will take some time to materialize. Scale is a top priority when offering advertisers a competitive product.

This initiative could be a major growth driver in 2025, with a lower entry point for new entrants and higher ARPU potential.

Paid Sharing Drives Growth
Netflix began tightening password sharing rules in the second quarter of 2023, limiting accounts to one household in the US (with the option to add an additional home for $2.99). The move aims to convert those who use shared passwords into paying subscribers.

• Estimated Impact: Management estimates that more than 100 million households used shared passwords. Strong subscriber growth in 2023 supports their hypothesis.
• Growth Potential: JPMorgan believes 62% of password borrowers could convert to paying members, potentially adding 36 million subscribers in 2024.

 3. Key Quotes from the Income Statement

Co-CEO Greg Peters on the decision to end split membership in 2025:

“This change is really motivated by a desire to focus on the key metrics that we believe are most important to the business. So we are going to report and provide guidance on revenue, on OI, OI margin, net income, earnings per share, free cash flow.”

Co-CEO Ted Sarandos on the importance of engagement:

“We believe this is the best indicator of member satisfaction with our offering and a leading indicator of retention and acquisition over time. So happy members watch more, stay longer, tell friends, all of which increases engagement, revenue and profit, our North Stars.”

CFO Spencer Neumann on the opportunity:

“Our share of television is less than 10% in every country in which we operate. There are still hundreds of millions of homes that aren't Netflix members, and we're just getting started with advertising."

4. What to see?

Netflix's massive reach, targeted promotion and personalized recommendations contribute to its ability to capture the zeitgeist.

For a letter to shareholders:

“Our trailers generate over 6 billion impressions each month on Netflix – more than 40 times more than on YouTube.”

Netflix had the number one original series in nine of the first 11 weeks of the year.

The top performing games in the first quarter included:

• Griselda (66.4 million views).
• Gentlemen (61.0 million views).
• 3 Body Problem (39.7 million views).
• "Avatar: The Last Airbender" (63.8 million views).

Additionally, The Snow Society (98.5 million views) became the second most watched non-English language film of all time.

And we're not just talking about Netflix originals. A show like Suits, acquired by Netflix in 2023, became the most-watched program of the year. Content creators recognize Netflix as an important platform for promoting projects, even those that are late in the life cycle. That's why you can find films like Dune (Warner Bros.) on Netflix before the second installment hits theaters.

Engagement is the north star because it impacts all performance metrics:

• Improved user retention (adherence to current shows).
• Attracting customers (through word of mouth and awards).
• Higher revenue per membership (due to low customer churn due to price increases).

I have yet to find a better measure of engagement than Nielsen's monthly market estimates of US TV time. It shows how Americans spend time watching TV across streaming, cable, broadcast and other categories (linear streaming, gaming).

Streaming accounted for 38.5% of U.S. television time in March 2024, up 4.5 percentage points from last year, according to Nielsen.

YouTube was the deciding factor, with a 9.7% market share, up from 7.8% a year ago. Alphabet executives regularly mention the living room as a critical growth initiative. Note that Nielsen's streaming segment does not include YouTube TV and Hulu Live.

In March 2024, Netflix took up 8.1% of TV time, more than Hulu, Prime Video and Disney+ combined. This figure is up from 7.3% a year ago, an impressive improvement compared to other SVODs.

While YouTube holds the lead in streaming in the US, Netflix maintains a significant lead over competitors in the live streaming space. The streaming market is growing rapidly, and Netflix is ​​well positioned for continued growth as it maintains its share of the growing pie.

With the introduction of live content, expanded gaming offerings and continued investment in diverse global content, Netflix has multiple opportunities to increase engagement and deepen monetization.