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Netflix's long-term prospects have not worsened

Netflix, stock, Netflix\'s long-term prospects have not worsened

Netflix (NFLX) results for October-December 2021 mostly coincided with consensus expectations, while management forecasts for the next reporting period greatly disappointed investors. After the release of the quarterly report, the shares of the streaming service fell by 20%.

The company's revenue grew by 16% YoY, to $7.71 billion, coinciding with preliminary market estimates. Operating margin exceeded investors' expectations, reaching 8.2%. GAAP EPS increased from $1.19 to $1.33 with the consensus of Wall Street experts at $0.83.

According to the results of the fourth quarter of 2021, the subscriber base expanded by 8.28 million to 221.84 million, slightly falling short of the expectations of investors and the initial forecast of management at the level of 8.4 million and 8.5 million, respectively. However, many investment houses have previously pointed out this risk, therefore, from our point of view, it was taken into account in the quotes even before the release of the report. The actual data turned out to be even better than some investors had expected. The dynamics of the service's audience growth really slowed down significantly in November after the decline in interest in the series "The Squid Game", but the end of the year turned out to be quite strong due to the busy release schedule and the seasonality factor.

Investors were disappointed by the following two aspects of the report:

  1. In the first quarter of 2022, the company forecasts an expansion of the subscriber base by only 2.5 million against consensus expectations of 5.8 million. Such a weak gain was an unpleasant surprise for all Wall Street analysts and investors. Management noted that this forecast reflects a higher density of premieres at the end of the quarter compared to its beginning, but the exact reason for the slowdown in audience growth is not yet clear. It is possible that this may be due to macroeconomic factors, as well as competition from other streaming services that are actively expanding geographically.
  2. According to management's expectations, the operating margin by the end of 2022 will be 19-20%, which is worse than the preliminary forecasts of investors. The possible strengthening of the dollar will put pressure on the indicator, since 60% of the streaming service's revenue is generated outside the United States, and its expenses are denominated mainly in American currency. According to Netflix, the strengthening of the dollar against major currencies over the last half of the year may lead to a decrease in revenue for 2022 by $1 billion.

Such a weak guidance of the management for the current quarter increases uncertainty about the long-term trajectory of audience growth. As a result, we lower the target price for NFLX paper on the horizon of the year from $690 to $505.

Despite the significant revision of the target, we still positively assess the long-term prospects of the issuer due to the following key factors:

  • The global transition from traditional TV to streaming will continue, and Netflix is the market leader. The company owns the rights to six of the 10 most popular (according to the Google search engine) TV series of 2021.
  • The subscriber base in the USA and Canada (in the home market of the service) grew by 1.2 million in the last quarter, to 75.2 million (with a consensus of +550 thousand), demonstrating the highest rate of expansion since the beginning of the pandemic. Consequently, the company is able to increase penetration in the most saturated market, despite the growing competition, which is a positive sign.
  • According to management comments, free cash flow will still remain positive in 2022.
  • Despite the growing costs of content creation, management maintains a target to increase operating margin at an average level of +3 percentage points per year, although investors were afraid of a decrease in the gaidens due to the acceleration of inflation. EPS in 2022-2025 may increase by more than 20% on average.
  • The schedule of movie and TV series releases in 2022 is characterized by balance, so audience engagement will be maintained at a high level throughout the year.
  • The epidemic factor no longer leads to delays in the filming process.
  • The company is still actively developing mobile games, so we expect that in order to form an experienced development team, Netflix will continue to enter into small M&A deals, but large acquisitions are unlikely. Netflix will create games based on popular TV series, experimenting with various genres.
  • We expect that in the coming year, investors will begin to perceive Netflix as a company with an effective business model, since the issuer will generate significant free cash flow and conduct a share repurchase program, while competitors are characterized by negative cash flow from streaming due to the smaller scale of the business.

Taking into account all these factors, we believe that the reaction of investors to the report is excessively negative, since the long-term prospects of the business have not deteriorated. We believe that the sell-off in the issuer's securities was caused not so much by a change in investors' expectations regarding the company itself, as by a temporary weakening of interest in the shares of most fast-growing chips against the background of the expected tightening of the Fed policy. For this reason, in the near future, Netflix shares may show sideways dynamics or even continue to decline. However, if there are these securities in the portfolio, we do not recommend getting rid of them, since the long-term prospects of the company, in our opinion, are still positive.

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