Streaming video giant Netflix (NASDAQ: NFLX) fell short of analyst expectations in Q2 FY2023 quarter, with revenue up 2.72% year on year to $8.19 billion. Netflix made a GAAP profit of $1.49 billion, improving on its profit of $1.44 billion, in the same quarter last year.
Netflix (NFLX) Q2 FY2023 Highlights:
- Revenue: $8.19 billion vs analyst estimates of $8.29 billion (1.24% miss)
- EPS: $3.29 vs analyst estimates of $2.85 (15.4% beat)
- Revenue guidance for Q3 2023 is $8.5 billion at the midpoint, below analyst estimates of $8.68 billion
- Free cash flow of $1.34 billion, down 36.7% from previous quarter
- Gross Margin (GAAP): 42.9%, up from 41.1% same quarter last year
- Global Streaming Paid Memberships: 238.4 million, up 17.7 million year on year
Launched by Reed Hastings as a DVD mail rental company until its famous pivot to streaming in 2007, Netflix (NASDAQ: NFLX) is a pioneering streaming content platform.
Netflix has a large and ever growing library of TV shows, movies, documentaries, and children’s programming. The company is known for its innovative approach to content delivery. For its first 10 years, that meant DVD rentals by mail with no return date. It launched streaming in 2007, which used customer data to surface programming that users might be interested in.
In 2013, the company began producing its own programming, weaning itself off of relying entirely on other company’s content. Hit shows such as "Stranger Things" and "The Crown" drew in audiences and kept them loyal to the platform. Today, Netflix generates revenue through its subscription-based model as well as an ad-supported one, with different plans at various price points.
For consumers, Netflix upended the traditional model of consuming content, flipping the paradigm from “appointment viewing” to a more customer centric “on demand viewing” Netflix’s granular viewing data also fundamentally altered what type of content was produced, stratifying what was once a handful of genres into dozens of niches that are able to find audiences in a sea of viewers. These innovations have been mimicked by many streaming services, and have become a quasi-standard of content consumption today.
Consumers today expect goods and services to be hyper-personalized and on demand. Whether it be what music they listen to or what movie they watch, or finding a date, online consumer businesses today are expected to delight their customers with simple user interfaces that magically fulfill demand. Subscription models have increased usage and stickiness of many online consumer services.
Netflix (NASDAQ:NFLX) competes with a range of streaming content rivals, from Amazon (NASDAQ: AMZN) and Disney (NYSE:DIS) to Paramount (NASDAQ:PARA) and Warner Bros Discovery (NASDAQ:WBD).
Sales Growth
Netflix's revenue growth over the last three years has been unremarkable, averaging 12.7% annually. This quarter, Netflix reported a rather lacklustre 2.72% year on year revenue growth, falling short of Wall St expectations.
Guidance for the next quarter indicates Netflix is expecting revenue to grow 7.25% year on year to $8.5 billion, improving on the 5.91% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 12.3% over the next twelve months.
Usage Growth
As a subscription app, Netflix generates revenue growth by growing both the subscriber base and how much each subscriber spends over time, on average.
Over the last two years the number of Netflix's users, a key usage metric for the company, grew 6.5% annually to 238.4 million. This is an ok growth for a consumer internet company.
In Q2 the company added 17.7 million users, translating to a 8.03% growth year on year.
Revenue Per User
Average revenue per user (ARPU) is a critical metric to track for every consumer internet product and for Netflix it measures how much the average users spends, one key indicator for how valuable its users are and can be over time. 
The ability to increase price while maintaining its users shows increasing value of Netflix’s platform. This quarter, ARPU shrank 4.91% year on year, settling in at $34.34 for each of the users.
Pricing Power
Netflix's gross profit margin, an important measure of pricing power and how much money a company gets to keep after covering the cost of providing its product or service came in at 42.9% this latest quarter, up 1.8 percentage points year on year.
For internet subscription businesses these costs typically include customer service, datacenter and infrastructure expenses, and the cost of content if the company's offering includes video or music services, for example. After covering those Netflix was left with $0.43 for every $1 in revenue to invest into sales, marketing and development of new offerings.
Netflix' gross margins have been trending down over the past year, averaging 38.7%. The weakness isn't great as Netflix's margins are already below other consumer internet companies as is, reflective of weakening pricing and cost controls.
User Acquisition Efficiency
Consumer internet businesses like Netflix grow by a combination of product virality, paid advertisement and occasional incentives, unlike enterprise products that are typically sold by sales teams.
Netflix is very efficient at acquiring new users, spending only 21.6% of its gross profit on marketing over the last year. This level of sales and marketing spend efficiency is indicative of a combination of scale and a strong brand reputation, which gives Netflix the freedom to invest its resources into new growth initiatives while still maintaining optionality in the business.
Profitability & Free Cash Flow
Investors typically look at a company’s operating income to get a sense of how profitable a core business is. Adjusted EBITDA is the most common profitability metric for consumer internet companies, similar to operating profit, but removes various one time or non-cash expenses to give a more normalized measure of profitability.
Over the last twelve months, the company has exhibited strong profitability with average EBITDA margins of 20.3%.
If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Netflix's free cash flow came in at $1.34 billion in Q2, up 10,419% year on year.
Netflix has generated $4.26 billion in free cash flow over the last twelve months, an impressive 13.1% of revenues. This extremely high FCF margin is a result of Netflix asset lite business model and strong competitive positioning, and provides it the option to return capital to shareholders while still having plenty of cash to invest in the business.
Key Takeaways from Netflix's Q2 Results
Sporting a market capitalization of $211 billion, more than $8.58 billion in cash and with positive free cash flow over the last twelve months, we're confident that Netflix has the resources it needs to pursue a high growth business strategy.
The positive this quarter was a big beat on global streaming subscriber net adds. Guidance for next quarter calls for similar net adds compared to Q2, which is also slightly ahead of expectations. However, it was unfortunate to see that revenue missed, implying that revenue per subscriber was below expectations. Additionally, the revenue guidance for the next quarter missed analysts' expectations. The market was also excited about advertising revenue from the company's ad-supported tier, but Netflix said that this revenue stream is not yet material, which is a slight disappointment. Overall, it seems to us that this was a complicated quarter for Netflix. The company is down 2.97% on the results and currently trades at $462.82 per share.
Is Now The Time?
When considering Netflix, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. Although we have other favorites, we understand the arguments that Netflix is not a bad business. Its revenue growth has been mediocre, but at least that growth rate is expected to increase in the short term. But while its gross margins make it extremely difficult to reach positive operating profits compared to other consumer internet businesses, the good news is its user acquisition efficiency is best in class.
At the moment Netflix trades at next twelve months EV/EBITDA 26.0x. We don't really see a big opportunity in the stock at the moment, but in the end beauty is in the eye of the beholder. And if you like the company, it seems that Netflix doesn't trade at a completely unreasonable price point.
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