Reports out of Europe that Netflix and YouTube were reducing streaming quality due to a surge in use were the first indications that the lockdowns were having the unintended side effect of potentially breaking the internet.
These reports also helped prompt investors to re-evaluate expectations around streaming company earnings, which had markets attempting to project how much Netflix, as well as their sector peers would beat their projections for Q1 subscriber growth.
In Netflix’s case they blew through their estimates, adding 15.8m new subscribers, well above the 7m estimate.
The biggest concern for Q2 as lockdown measures were eased is whether Netflix would be able to add to these numbers, or whether we would see a Q2 drop off, on account of a pull forward effect.
In Q1 revenues came in at a record $5.77bn, while market reaction to last night’s Q2 numbers would appear to suggest that the big run higher may well have run its course, despite the company adding over 10m new subscribers to its consumer base, well above expectations of 7m.
The company also saw revenues rise to $6.15bn, again beating expectations as new users feasted on a raft of new content which included Michael Jordan’s documentary “The Last Dance”, however profits came in short of expectations of $1.81c a share at $1.59c, largely due to a one-off charge.
Despite the better than expected revenue and subscriber numbers, caution over Q3 appears to have prompted some caution as the shares slipped sharply in post market trading after the company warned that new subscribers in the upcoming quarter may well come up short due to pull forward effects starting to wane as lockdown measures continue to get eased further, as we head towards the end of the year.
Management estimates for new subscribers in Q3 were set very low at 2.5m new subscribers, well below expectations of 5.3m, while revenue estimates were set at $6.33bn, also below analyst estimates.
Netflix went on to say that it doesn’t expect the current production shutdown to impact its 2020 content slate in a significant fashion, however some new content may well get pushed back towards the back end of 2021.
On an even more positive note the company was cash flow positive for Q2, and said it was optimistic that free cash flow would break even by year end, as it continues to narrow the gap between what it spends, and what it has coming through the door in revenue.
To sum up, last night’s negative reaction to Netflix’s guidance may be more to do with much of the good news being already priced in, as well as some investors setting their expectations a little too high.
There is certainly a case for arguing that Netflix isn’t worth the high valuation assigned to it by the markets, however one can’t argue the fact it is number one in its field by some distance, and continues to set the bar, as far as its peers are concerned. Netflix has still had a stellar year so far in terms of new subscribers so it’s completely understandable for management to reset expectations a touch, given that in the space of two quarters, the company has added nearly as many subscribers as they did in 2019, when they added 27.83m new customers
Netflix management appears to be being prudent in resetting market expectations, given recent gains in the share price, while they also announced that chief content officer Ted Sarandos was being elevated to co-CEO alongside Reed Hastings. Whether that is a wise move or not depends on your view about the wisdom of having two CEO’s.
By Michael Hewson (Chief Market Analyst at CMC Markets UK)
This article was originally posted on FX Empire
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