Shares of Netflix Inc (NFLX, Financial) tanked 6% in after-hours trading on July 19 after reporting second-quarter earnings. Leading up to the earnings release, the stock had gained nearly 60% this year with investors expecting a strong rebound in subscriber growth.
The company’s performance in the second quarter was characterized by the success of newly launched growth strategies, such as the ad-supported streaming tier and the crackdown on password sharing. The early success of these strategies suggests Netflix Inc (NFLX, Financial) is entering a new phase of business, where it will try to strike a balance between growth and profitability.
Strong progress from new initiatives
Netflix Inc (NFLX, Financial) posted revenue of $8.19 billion for the second quarter, an increase of just 2.8% from the prior-year period. It also fell short of estimates of $8.30 billion. However, the reported earnings per share of $3.29 were well ahead of analysts' expectations of $2.85. The earnings beat came on the back of the operating margin expanding to 22.3% from 19.8% a year ago.
The real highlight was the addition of 5.9 million net paid subscribers in the second quarter, which establishes the company as the undisputed leader in the global streaming market. Despite many of its peers struggling to add new subscribers, Netflix Inc (NFLX, Financial) added almost 6 million subscribers due to the early success of its paid sharing program and the ad-supported tier.
Success of Paid Sharing Program and Ad-Supported Tier
In May, the company rolled out paid sharing in 100 countries. Encouragingly, revenue in each of these regions increased following the rollout. Building on the notable success in these markets, the company will now extend the password-sharing crackdown to all of its markets around the world. Going by the early results, the company seems well-positioned to grow its subscriber base.
The ad-supported plan has also gotten off to a promising start. After launching the ad-supported tier last November, the company has continued to improve this product for both advertisers and subscribers. In its second-quarter letter to shareholders, Netflix Inc (NFLX, Financial) revealed that it is partnering with Nielsen and EDO to improve performance measurement tools available for advertisers.
Attracting Advertisers and Monetizing User Base
This is an important step as advertisers expect the availability of a wide range of measurement tools to evaluate how users are engaging with advertisements. The massive success of Meta Platforms Inc (META, Financial), for example, was driven by the company’s commitment to providing a robust set of tools to marketers to help them reach their target audience. Netflix Inc (NFLX, Financial) also revealed that ad-supported plan subscribers have doubled since the first quarter, which is a clear indication users are embracing this new option.
To attract advertisers, Netflix Inc (NFLX, Financial) is now offering an option to buy media assets in the Top 10 list curated by Netflix daily. This is a good strategy as advertisers can potentially reach a wider audience by placing their ads on the most popular content on Netflix at any given time. The company will be able to charge higher prices for placing ads on Top 10 content, which will be a win-win for both parties.
After digesting the early results of the ad-supported plan, Netflix Inc (NFLX, Financial) has decided to remove its lowest-priced ad-free plan in the U.S. While new users previously had the option to subscribe to the ad-free Basic plan at $9.99 per month, it will no longer be offered. The rationale behind this decision is to drive traffic to the ad-supported plan that is offered at $6.99 per month and increase sign-ups to the Standard plan at $15.49 per month, which comes without ads. By clearly defining the value proposition of each of these subscription plans, the company believes it will be able to monetize its user base better.
Content leadership
High-quality content can and will play a major role in differentiating the winners from losers in the ongoing battle for streaming supremacy. Netflix Inc (NFLX, Financial), with its deep content library, is winning this battle currently. Nielsen’s most recent data for the week ended June 18 established the company's dominance in the streaming sector. In the original series category, Netflix secured eight out of the top 10 positions, including the top three positions.
A steady flow of high-quality original content is key to attracting new subscribers and retaining existing ones, and Netflix, over the years, has found a balance where it can produce original content at an acceptable pace while securing its profitability.
Netflix's Dominance in the Streaming Market
The streaming pie is continuing to grow, but Netflix Inc (NFLX, Financial)’s dominance remains unthreatened. According to Nielsen’s June data, streaming accounted for 37.7% of U.S. TV screen time, a notable improvement from 26% in May 2021. This growth came at the expense of cable TV and broadcast TV viewership. In the streaming category, Netflix accounted for 8.8% of screen time in June, substantially ahead of its main competitors with Prime Video, Disney+ and Peacock registering a market share of 3.2%, 2% and 1.2%, respectively.
Takeaway
With the help of new growth initiatives, Netflix Inc (NFLX, Financial) has entered a new growth phase where it is trying to balance growth and profits. The expansion in operating margins, the early success of its new products and the continued content leadership in the second quarter suggest the company is well-positioned to grow. Most of the expected growth, however, has been baked into Netflix’s current valuation, with the stock trading at a forward price-earnings ratio of 42. Investors will have to keep an eye on its valuation, though Netflix’s growth story is far from over.
