The good, the bad and the downright ugly as investors brace for Q2 earnings

Netflix (NFLX) reports Q2 earnings after the bell on Tuesday — and investors are bracing for impact.

The streaming giant said it expects to report a loss of 2 million subscribers for the second quarter after announcing an unexpected first-quarter subscriber loss of 200,000 users in April.

Netflix stock, currently trading at around $180 a share, has plummeted 70% year-to-date amid a broader market sell-off that’s slammed growth stocks and fueled talk of a potential recession.

Here’s the good, the bad, and the downright ugly when it comes to Netflix ahead of next week’s earnings.

The good

Netflix’s upcoming ad-supported tier, coupled with a crackdown on password sharing, should help boost revenues as the platform grapples with a post-COVID slump in subscribers.

The streaming giant will partner with Microsoft (MSFT) to help roll out the new offering, which is expected to hit the market later this year (although some analysts think otherwise given Microsoft’s lack of experience in the third-party ad tech business.)

Still, Wall Street is generally bullish on ads.

“Tapping into the $160bn global video advertising spending opportunity in the long term should allow Netflix to drive average revenue per unit (ARPU) growth with less reliance on consumer price increases,” Morgan Stanley analyst Benjamin Swinburne emphasized in a new note.

He added, “In markets with high ad ARPUs, like the U.S., Netflix can offer a materially lower priced offering and unlock additional net adds without sacrificing unit economics. Advertising may also prove a consumer-friendly way to monetize password sharing.”

Swinburne, who lowered his price target on the stock from $300 to $220 a share, revealed that the bank will need to see net adds reaccelerate, in addition to signs of traction from advertising and password sharing monetization over the next 12 months in order to revert back to a $300 bull case.

All in all, the analyst said ARPU growth matters more than net adds, suggesting Netflix will continue to raise prices down the line, in addition to leaning on revenue generated by ad-supported.

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Netflix’s strong slate of original content — from “Stranger Things” to “Squid Game” — should help the platform attract new users and maintain existing ones.

“Stranger Things” season 4, in addition to breaking the record for Netflix’s biggest ever premiere weekend, earned the highest viewership among all English-language Netflix seasons, with 930.3 million hours viewed in its first 28 days.

Still, the Duffer Brothers’ production was not able to eclipse South Korean smash hit “Squid Game,” which nabbed 1.6 billion hours over that same time period.

Both titles received a slew of Emmy nominations this year, including a best drama nod for “Squid Game,” which will battle award show darling “Succession” for the top prize.

Other originals like “Bridgerton,” “The Witcher,” “The Umbrella Academy,” and “You” also contributed to significant spikes in global viewing following their respective premieres — another sign that content is still king for streamers.

Amid shrinking subscriber growth, Netflix has begun to trim costs and focus on expense management — a positive in regards to free cash flow, which investors have frequently criticized.

Job postings for the company are at all-time lows — down 55% year-over-year, according to Thinknum data, cited by Bank of America.

In June, the company laid off around 300 employees to combat “slower revenue growth.” The job cuts followed Netflix’s last round of layoffs in May when the streamer laid off 150 members of its workforce.

Bank of America said Netflix’s most recent layoff announcement suggests that “the company may be beginning to adjust its content cost focus as a means of right-sizing expenses (e.g., cutting staff from niche programming/content exploration).”

The Bad

Bank of America expects subscribers to peak in the U.S. and Canada in three years with 80 million users, while international subscribers are estimated to hit 220 million in 18 years.

Potential peak subscriber penetration has contributed to lower price targets and bearish sentiments from analysts in regards to subscriber growth.

Many have cautioned that, if the U.S. saturation point approaches more quickly than expected, it could result in a major downside risk, especially amid increased competition.

FX pressures continue to cause problems for Netflix.

Bank of America said it expects “Foreign Exchange (FX) to creep further into the discourse as the dollar shows no near-term signs of weakening relative to the overall basket of currencies.”

The bank estimates that Netflix could see about $267 million of FX headwinds to revenues in the second quarter, noting that ARPUs in developed markets have decreased -4.4% to $13.16 while emerging markets slipped -4.0% to $9.47 when compared to the bank’s last check on April 15.

The Ugly

“Streaming video revenues may prove more vulnerable than expected to a global recession and lower consumer spending levels,” Morgan Stanley’s Swinburne said in his note, citing the streamer’s pricing premium as a net negative for customers looking to trim their streaming bill.

Bank of America added that a recession scenario could drive higher subscriber churn and/or limit pricing power — both major risks to the downside.

Competition, which has intensified over the last few years, continues to put upward pressure on churn — and could even derail Netflix’s promising ad-supported plan with Disney+ (DIS) also set to roll out its own ad-supported tier by the end of this year.

According to recent data, cited in a note by Bank of America, customers across all income levels would switch to a discounted ad-based alternative — however, “ad-tiering could serve as a way for consumers across all income brackets to extend their streaming budget by trading down to subscribe to an additional service, benefiting Netflix’s competitors much more than Netflix itself.”

Additionally, competition could potentially limit growth in new markets, which Netflix will need to rely on once peak penetration hits the U.S.

Alexandra is a Senior Entertainment and Food Reporter at Yahoo Finance. Follow her on Twitter @alliecanal8193 and email her at [email protected]

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