Password Sharing Crackdown And Ads Coming As Netflix Growth Bounces Back

Key Takeaways

• Netflix reversed their subscriber losses in Q3, adding 2.4 million new accounts
• Earnings per share are down from last year but beat analysts forecasts by 48%
• The positive result has been largely attributed to the new season of Stranger Things and the popular Jeffrey Dahmer mini-series
• The strong US dollar is putting pressure on earnings, but a crackdown on password sharing and a new ad-supported pricing tier is expected to keep growth steady

It’s really been nothing but bad news for Netflix and its shareholders over the past year. In Q1 they announced that they’d lost subscribers for the first time in a decade, shedding almost 200,000 accounts. They followed this up with an even worse figure in Q2, dropping 1 million subscribers.

That is not the trajectory that any business wants and it led to the Netflix share price dropping by as much as 72% through the early part of 2022.

With a big push from the new season of Stranger Things and Dahmer – Monster: The Jeffrey Dahmer Story, Netflix has managed to turn things around in Q3, adding 2.4 million subscribers.

That’s a big, flashy number, but the most important point is that it’s almost double the amount that Netflix had projected. Wall Street loves a good surprise and the Netflix share price jumped as much as 15.5% off the back of the announcement.

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The Netflix numbers

The relief was palpable on the earnings call, with chief executive Reed Hastings saying “Thank God we’re done with shrinking quarters. We’re back to positivity.”

The large increase in subscriber numbers was the headline and while earnings per share were down compared to the same time last year, they were also significantly higher than analysts estimates.

Net income decreased from a year ago from $1.44 billion to $1.4 billion, and earnings per share were down 2.8% to hit $3.10. This figure was a mile higher than the $2.10 that had been expected.

Netflix also used their letter to shareholders to talk about their increasing level of competition.

In a sector that Netflix created, they now share space with a mind boggling number of alternative streaming services. Amazon Prime, Disney+, Apple TV+, Hulu, HBO Max, Paramount+ and many, many others are all now fighting for a share of the streaming pie.

Netflix were eager to point out that their service offers a higher level of engagement than any other streaming network. In the US, Netflix takes up 7.6% of users ‘TV time,’ which is 2.6 times the number for Amazon Prime and 1.4 times the amount for Disney+ and Hulu.

They also highlighted how expensive it is to grow a streaming service, suggesting that their competitors are likely to be operating at combined annual losses of around $10 billion. They compared this to the profit being generated by Netflix of between $5 – $6 billion per year.

Year on year revenue has increased 6%, though this was impacted by changes in exchange rates which have been unusually volatile this year. A strong US dollar has meant foreign earnings are converting back to less USD.

Taking out the impact of foreign currency movements showed that structural revenue had actually increased by 13%.

Major changes coming to Netflix

There are big changes coming for the company over the next few months. Just six months after the initial announcement, Netflix will be rolling out their lower cost, advertising supported tier to twelve different countries.

This partnership with Microsoft will see Netflix contain traditional advertisements for the first time. Some analysts have raised concerns about the fact that it could see current paying subscribers move to the lower cost plan.

Chief product officer Greg Peters addressed this question directly, stating that Netflix aren’t concerned about “plan switching” and don’t expect many users to do it. Whether this proves to be the case in an economy that sees households under ever increasing cost pressures will remain to be seen.

The other major change on the close horizon is the planned crackdown on password sharing. This plan won’t see sharing banned altogether, but will instead allow a main account holder to create sub accounts which allow other users access for a discounted price.

The Q4 forecast

After seeming to right the ship in Q3, the forecast provided for Q4 was reasonably muted. The strength of the US dollar is continuing to be a key area of concern for Netflix and all other US based companies who operate globally.

Essentially, a strong US dollar (USD) means that revenue generated overseas is worth less in USD terms. A UK Netflix subscription of £9.99 in October last year would have provided approximately USD$13.79 in revenue for Netflix. That same £9.99 account right now is converting back to just USD$11.29.

It’s a widespread issue given that the USD has strengthened against almost all other major currencies over the past 12 months.

Netflix are projecting Q4 revenue to hit $7.8 billion compared to $7.9 billion in Q3 and they’re attributing all of this decline to the strong US dollar. Removing the impact of currency movements they project revenue to grow 9% year on year.

Netflix to no longer provide forward guidance on memberships

Interestingly Netflix also announced that they’ll stop providing forward guidance on membership numbers. Obviously these figures have been under immense scrutiny over the past twelve months, with performance against expectations having almost as much of an impact as outright growth or decline.

The reasoning behind this is as the business model matures, outright subscriber growth isn’t necessarily the best metric for business performance. When Netflix revenue model was based purely on one or two simple price points, subscriber growth was an easy metric to gauge improvements in revenue.

Now, with the introduction of advertising revenue and sub-accounts at lower price points, it becomes a little more complicated. As you’d expected, forward guidance will continue on financial metrics such as earnings per share and revenue.

What does this mean for investors?

Netflix may be down, but they’re certainly not out. The game has changed substantially since they first pioneered the world of streaming, but it’s clear to see they are making major efforts to keep their business profitable and sustainable.

The tech industry can be volatile and we’re seeing a great example of that in the Netflix story. For investors, it can be incredibly difficult to know which companies are likely to continue to see strong growth trajectories, and which are ripe for disruption.

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