Netflix, Inc. (NASDAQ: NFLX) delivered a mixed set of results for the first quarter of the 2023 fiscal year, leaving investors glued to their screens in an attempt to find potential catalysts for what seems to be a saturated market. Ultimately, investors were left disappointed, sending the share price tumbling 3% in Wednesday trading. 

The streaming and entertainment giant reported earnings per share of $2.88, down 18% from a year-ago, while missing the $2.86 analyst expectations. Their top line expanded by 4% from the prior year’s quarter to $8.16Bn but fell short of the $8.18Bn expectation. However, the biggest disappointment came in the form of subscriber growth, slowing down more than investors feel comfortable with. Heading into the latter parts of the year, investors would keep an eye on subscriber growth as a deeper story unfolds around the potentially exhausted market.  

Technical 

On the 1D chart, a symmetrical triangle has formed after the bulls failed to push higher than the early February peak of around $379.43. Since then, the price action trended down, reaching a swing low at $285.33, where the market provided support to start the retracement. 

Prior to the earnings, the share price reached the Fibonacci midpoint at $333.87 before the gap down to close at $323.12 on Wednesday. The share price is now approaching the triangle support. If the bears break down the triangle, a leg down toward the 23.6% Fibonacci retracement level at $309.67 is on the cards, where a support failure could open the door for further downside toward $303.84 and $288.04 to retest the mid-March bottom.  

However, the estimated fair value of Netflix on a discounted cash flow basis is around $354.93. This presents a 10% potential upside from current levels, with any downside movements opening up the potential for larger upside possibilities. A retest of the March lows could shift the upside potential to 23% if the company can converge to its estimated fair value.  

Fundamental 

Following the earnings release, investors have debated the growth potential of Netflix heading into the latter parts of the year, as there are growing concerns about a potential maturity in the market. In the first quarter, subscriber numbers grew by 1.75M, lower than the 2.2M expected by the market. The company only added 100 000 new paid subscriptions in the US and Canada, with 640 000 and 1.46M added in the EMEA and Asia Pacific regions, respectively. This is where the bearish argument comes in, as the company gained 7.66M subscribers in the last quarter of 2022. Investor concern lies around the ability of the company to sustainably grow its customer base, especially during a period of economic downturn where consumers are expected to undergo budget cuts. To aid their argument, Netflix also missed estimates with their guidance for the upcoming quarter. Earnings per share for the upcoming quarter were projected at $2.84 on revenue of $8.24Bn. Analysts were expecting earnings per share of $3.07 on revenue of $8.47Bn.  

However, with a whopping 232.5M global subscriber count, the bulls are arguing that the company’s focus could lie in monetising its existing base and extracting more revenue from a large number of customers already on its platform. Hidden in this 232.5M customer base are around 100M more users currently using their service without paying for it through account password sharing. Netflix has started implementing measures to address this problem by announcing a crackdown on password sharing, which they planned to implement in the latter parts of their first quarter. These measures include paid sharing accounts. However, the rollout of this plan got delayed to the second quarter of 2023. Now, there are concerns about a loss in subscriber numbers due to cancellations through the rollout of this plan, with no guarantee of activating new accounts. However, they have started implementing these measures across Canada, New Zealand, Portugal and Spain. While management admitted that they experienced some cancellation reactions, the results they have seen from these regions have convinced them that they are on the right path to unlock incremental revenue from their massive customer base. Netflix has also taken measures to address the concern around cancellations by implementing its ad-supported subscription plan, which is cheaper than its basic plan. This plan will target lower-budget consumers who may have been reliant on password sharing. 

From the early implementation of their ad-supported plans, management has concluded that these cheaper plans generate a higher average revenue per user, as the advertising revenue offsets the cost reduction. This poses well for future growth, as their content spending can remain stable while generating higher revenues per user on the lower cost plan. The company is using these additional revenues from paid sharing and ad-supported subscriptions to improve their user experience, aiding them in member retention. For example, they have recently recalibrated their ad-supported plan to include 1080p video quality, similar to their basic plan.  

While the bulls and the bears both have an argument, there are some risks that all investors could agree on. The entertainment industry is currently under disruption by multiple competitors, all fighting for market share. With Netflix cracking down on password sharing, they could lose some market share to other players. Macroeconomic headwinds also exist, with high inflation eating into the consumer’s budget, which could force them to cut down on discretionary spending. A strong US dollar also weighs on their average revenue per membership, and with more interest rate hikes to come, there could be further pressure on their top line. At the same time, analysts also agreed on the company’s healthy free cash flow generating ability. For the first quarter of the 2023 fiscal year, the company produced a free cash flow of $2.12Bn, exceeding its full-year 2022 free cash flow of $1.62Bn. Guidance for the upcoming year of at least $3.5Bn in free cash flow also exceeded the previous outlook of $3Bn. The improved free cash flows could ultimately open up more potential for stock buybacks to reward its shareholders. 

Summary 

A mixed set of results was not well received by Netflix investors. However, if their ad-supported and paid-sharing initiatives gain traction in the upcoming quarters, they could unlock incremental value from their large customer base. In this case, the company could converge to its estimated fair value in the long term toward $354.93.  

Sources: Koyfin, Tradingview, Reuters, Yahoo Finance, Netflix, Inc.