Netflix Q1 subscriber additions of 9.33 million doubled expectations, but hinted at slowing growth, dropping 7% after hours | Financial Report Insights

After the US stock market closed on Thursday, April 18th, the streaming giant Netflix announced a positive first quarter 2024 financial report. Its paid users increased by 9.33 million, nearly doubling market expectations. However, the stock price rose by 3% after hours, then quickly fell by 7%.

Some analysts believe that this is because the company warned that "typical seasonal factors will result in lower user growth in the second quarter than the first quarter," implying that the positive momentum of user growth will slow down, leading to a decline in the stock price after hours.

Last year's record-breaking addition of new users in the fourth quarter raised high expectations for Netflix's continued positive momentum in 2024. Among analysts covering Netflix, 26 rated it as "buy", 13 as "hold", and only 1 recommended "sell".

However, Wall Street's average target price for the stock in the next 12 months is $598.98, about 2% lower than the current stock price. Netflix has hit a 52-week high for six consecutive months, but is still 11% below its historical high at the end of 2021.

Netflix's Q1 revenue increased by 15% to a two-year high, with profit margins at a three-year high and new user numbers doubling expectations.

Netflix's first-quarter report exceeded expectations. Revenue for the quarter was $9.37 billion, up 15% year-on-year, with an EPS of $5.28, up 83% year-on-year. Net profit increased by 79% to $2.33 billion, operating profit increased by 54% to $2.6 billion, operating profit margin increased by 7 percentage points to 28% year-on-year, all well above market expectations and company guidance.

According to data provider LSEG, analysts expected Netflix to generate $9.27 billion in revenue in the first quarter of this year, a 13.6% increase from the same period last year. EPS was expected to be $4.52, a significant 57% increase from $2.88 in the same period last year.

These market expectations slightly exceeded Netflix's first-quarter revenue guidance of $9.24 billion, representing a 13.2% year-on-year increase, the largest revenue increase in over two years. Netflix also expected an operating profit margin of 26.2% for the quarter, the best in three years since the first quarter of 2021. The company projected a 51% year-on-year increase in net profit to $1.98 billion, and a nearly 56% increase in EPS to $4.49.

Since the first quarter of last year, Netflix has stopped providing guidance on subscriber growth for the next quarter, instead using revenue growth as the main indicator for evaluating the company's overall development. However, Wall Street expects a user increase of 4.88 million in the first quarter of this year, nearly three times the 1.75 million in the same period last year.

The actual first-quarter report shows that Netflix added a net 9.33 million streaming paid users, bringing the total global paid membership to 269.6 million, up 16% year-on-year, reaching a new historical high, and exceeding analysts' expectations of 264.5 millionAmong them, the number of paid users in the largest market, North America, increased by 2.53 million, far exceeding the market's expected increase of 0.9886 million. The number of users in the Asia-Pacific region increased by 2.16 million, surpassing analysts' expected increase of 1.48 million.

According to the financial report, Netflix currently has subscriptions from nearly 270 million households in over 190 countries/regions globally. Calculated with an average of over two people per household, its audience has exceeded 500 million, ranking first in the entertainment industry.

The company also stated that the number of subscribers with ad-supported plans in the first quarter increased by 65% compared to the fourth quarter of last year, maintaining a trend of nearly 70% sequential growth from the third and fourth quarters of last year.

Netflix expects a 16% increase in revenue in the second quarter , and will no longer disclose quarterly membership numbers and other key metrics in next year's first quarter report

In terms of financial guidance, Netflix expects revenue growth of 13% to 15% for the 2024 fiscal year, maintaining a healthy double-digit growth rate. Based on the exchange rates as of January 24th, the forecasted operating profit margin for the year has been raised to 25%, higher than the market's expected 24%.

Netflix also maintains its expectation of approximately $6 billion in free cash flow for the full year, slightly lower than analysts' expectations of $6.49 billion, and keeps the expectation of maximum content spending in 2024 at $17 billion.

The company expects earnings per share (EPS) of $4.68 in the second quarter, higher than analysts' expected $4.54, with expected second-quarter revenue of $9.49 billion to $9.51 billion, a 16% year-on-year increase.

In addition, Netflix generated $2.2 billion in net cash from operating activities in the first quarter, with a total free cash flow of $2.1 billion, both in line with the same period last year. During the reporting period, the company repaid $400 million in senior notes with cash on hand and repurchased 3.6 million shares for $2 billion. Total debt at the end of the quarter was $14 billion, with cash and cash equivalents at $7 billion. The company also expanded its revolving credit facility from $1 billion to $3 billion.

Netflix stated that its reporting rules for paid membership numbers will change again, starting from the first quarter report in 2025, quarterly membership numbers and Average Revenue per Membership (ARM) will no longer be reported, and annual revenue guidance will be added as a sub-item. However, milestones in subscriber numbers will still be announced:

"We will treat revenue and operating profit as the primary financial metrics and use engagement (i.e., time spent by users) as the best indicator of customer satisfaction.

In the early days of the company, when there was almost no revenue or profit, membership growth was a strong indicator of our future potential. But now we are generating significant profits and free cash flow, and developing new revenue streams such as advertising and additional membership features, so the number of members is just one component of the company's growth metrics."

Why is it important? Or how does it affect the financial reports season of tech stocks and the overall market trend?

Netflix is the first major American tech company to announce its first-quarter results. Its performance and subsequent stock price performance can not only reveal and lead the trend of tech stocks, but also play a crucial role in the trajectory of the entire market. Some analysts believe that if the stock suffers a heavy blow, it may represent that the overall stock market is overvalued and trigger profit-taking.

As Netflix announces its financial report, market sentiment is deteriorating rapidly. The Nasdaq fell 4.6% from its historical high within a week, mainly due to the March U.S. inflation data exceeding expectations, leading to a surge in bond yields and dealing a heavy blow to growth-oriented tech stocks.

The Motley Fool, a U.S. stock research website, points out that historically, investors tend to penalize positively performing companies during deteriorating market sentiment, adding uncertainty to the stock price prospects of large tech companies after their financial reports.

What to focus on? User growth, advertising, price hikes, and sports live streaming

The competition in the streaming media sector is fierce, with traditional giants like Disney and Paramount Global, as well as newcomers like Amazon and Apple, vigorously competing for market share. As the world's largest streaming media platform, stable growth in subscription users remains a key indicator in Netflix's financial report.

Investors will also focus on whether the advertising business launched in November 2022 has actually begun to improve the company's financial performance, and how measures to combat password sharing of paid accounts in major global markets will affect user numbers.

With the support of these two measures, following a significant slowdown in 2022, Netflix's subscriber growth significantly rebounded in 2023. The number of members in the advertising package has increased by about 70% for several consecutive quarters, although the company has not disclosed specific numbers. It recently stated that there are over 23 million monthly active users globally using the ad-supported plan.

The market is also awaiting news of Netflix's package price hikes. During the Q4 earnings call last year, Co-CEO Greg Peters hinted that due to cracking down on password sharing, the company had basically suspended package price increases last year, but "now that we've completed that task, we can return to the standard way of raising prices, and the trial price increases in the U.S., UK, and France have performed better than expected."

Live entertainment may be a future growth highlight. Earlier this year, Netflix announced that it had acquired the exclusive media rights to the flagship weekly wrestling program "Raw" from the U.S. professional wrestling league WWE for ten years starting in 2025, marking its first foray into sports live streaming business, requiring an annual payment of about $500 million. Netflix also hosted a live tennis match in March and invited Tyson to participate in a live boxing match in July.

How does Wall Street view it?

Wall Street generally bets on Netflix maintaining an upward trend in 2024. Before the release of the Q1 financial report, mainstream investment banks such as Morgan Stanley, JPMorgan Chase, Barclays, UBS, Wedbush, Guggenheim, Macquarie, and TD Cowen all raised their target pricesThis is mainly due to the company's acquisition of as many as 13.1 million new subscription users in the fourth quarter of last year, representing a strategy to combat password sharing that is driving more people to convert to paid members.

Morgan Stanley said Netflix "remains the undisputed leader in the streaming TV field", and the crackdown on password sharing and lower-priced ad-inclusive packages "has successfully re-accelerated the growth of subscription users and unit member average revenue". Netflix previously estimated that there are approximately 100 million users worldwide sharing passwords, which could provide more room for subscriber growth by 2024:

"Investors should focus on Netflix's unit member average revenue, as its monetization capabilities with ad-inclusive packages and subscriber pricing may increase. Netflix's mid-tier ad-free package in the U.S. is priced at $15.49 per month, lower than competitors like Hulu. Moreover, its user base for ad-inclusive packages is growing, providing it with greater scalability potential and pricing power in the improving ad market.

Since January 2022, Netflix has not raised the price of its standard package (i.e., the aforementioned mid-tier ad-free package), and we believe Netflix's pricing power advantage over competitors will lead to imminent price increases."

UBS Securities also expects Netflix to continue to gain a larger share of overall TV viewing and have an average price lower than competitors when calculated by consumption hours. This "strong pricing power" will allow it to raise subscription prices this year, accelerating revenue and profit growth. Combined with revenue growth from advertising and healthy user growth, Netflix's total revenue in 2024 may increase by 15%, doubling the growth rate of 7% from last year.

UBS stated that as the overall goal of streaming shifts from user growth to profitability, Netflix "is the main beneficiary of structural changes in the media industry". New strategies to increase profitability include: subscription price increases, platform integration, film library management and the resulting asset write-downs, reduction in content spending, and a renewed emphasis on content licensing and authorization:

"We have raised our expectation for Netflix's net new subscription users in 2024 from 18 million to 20 million, to reflect the continued momentum of subscriber growth, the upward trend in unit member average revenue, and higher operating leverage.

Due to Netflix's successful implementation of the crackdown on paid account password sharing globally, its net new subscriber count in 2023 was 29.5 million, higher than the annual average of 21 million from 2020 to 2022.

While we expect the net growth rate of subscription users to slow down, we also believe that Netflix still has significant room for development, as it will continue to convert users into paid members and attract new users, hence the upward revision of free cash flow expectations to 2027."

Morgan Stanley believes that the "breakthrough original hit series" launched by Netflix in the first quarter of this year is more than in the fourth quarter of last year, which will lead to higher-than-expected user growth and drive profit growth:"The market may underestimate the benefits Netflix gains from non-English content, the depth of viewing of thousands of films, as well as the impact of Netflix's original content and exclusive streaming rights on its platform.

These advantages give Netflix a structural competitive edge, coupled with its expansion into new businesses such as advertising, gaming, and sports live streaming, all reinforcing our optimistic view on its long-term business growth and return on capital."

In addition, TD Cowen is bullish on the dual drivers behind Netflix, namely the financial gains from cracking down on password sharing of paid accounts, and the "strong and increasingly globalized content sector bringing robust potential commercial demand." Wedbush Securities also believes that advertising, gaming, and more licensed IP allow Netflix to "manage content costs and maintain a leading position in content consumption among streaming peers."

However, investment management firm MoffettNathanson warns that cracking down on password sharing may front-load Netflix's user growth, as it does not change a fundamental fact that the number of households in the largest market, North America, not yet subscribed to Netflix is decreasing. Similarly, brokerage firm Piper Sandler, which maintains a "neutral" rating, is concerned that the market's expectations for Netflix's user growth may be too high.

Some analysts also suggest that Netflix's investments in gaming, live streaming, and sports-related content may bring good revenue increments but could impact profits. Netflix is aggressively promoting cheaper ad-supported plans, combined with higher digital marketing expenses, which could squeeze profit margins