Netflix’s Password Problem, Slow Ad Tier Lead Wall Street to Lower Earnings Targets

Wall Street analysts lowered their growth forecasts for Netflix’s third-quarter earnings and slashed price targets for the streaming company’s stock as they await further clarity on the company’s growth strategy.

The changes for Netflix, which will report after the bell on Wednesday, come as analysts surveyed by Zacks Investment Research are expecting the company to report earnings of $3.47 per share on revenue of $8.54 billion for the quarter.

The streamer, which unlike its legacy media competitors is profitable, has shifted its focus to an ad-supported tier and a crackdown on password sharing for an estimated 100 million households globally as it looks to accelerate revenue growth, expand its margins and continue to grow positive free cash flow.

Netflix co-CEO Ted Sarandos acknowledged during Bloomberg’s Screentime conference on Thursday that the company’s ad tier is still in its infancy and “definitely not at the scale that we want it to be at yet.” In August, Netflix’s ad-supported tier surpassed 10 million monthly active users globally, double the five million MAUs reported in May.

Co-CEO Greg Peters previously said the effect of the company’s paid sharing initiatives (the password-sharing crackdown), which launched in over 100 countries including the U.S., would take “several quarters” to be felt.

Investors also expressed disappointment last month when Netflix chief financial officer Spencer Neumann signaled that operating margins would grow more gradually as the company focuses on investing in growth opportunities. At the time, he said he didn’t view it to be “prudent for us to keep growing at three percentage points of margin per year” and anticipated that Netflix’s margins in 2023 would be in the range of 18% to 20%.

On Friday, Wolfe Research analyst Peter Supino downgraded Netflix from an outperform to peer perform rating and removed his previous $500 price target on the company’s shares.

Netflix should continue to gain share of the global premium video revenue pie, Supino wrote, with pay TV accounting for more than 50% of viewership. And the company is “on course to build a massive advertising business for the long-term.” Nevertheless, the Wolf Research has “rising concern about 2024-25 growth forecasts.”

The firm’s previous outperform rating anticipated Netflix “leading the industry transition from land grab to efficiency” by monetizing existing viewership via the ad tier and paid sharing features.

Supino added that the two largest drivers of the company’s multiple — net subscriber additions and operating margins — are looking “increasingly risky.” He lowered his calendar year 2024 net additions to 11 million, versus the consensus of 16 million, as “the paid sharing catalyst fades and price increases weigh on net adds.”

Piper Sandler analyst Matt Farrell maintained a neutral rating on the stock but cut its price target from $440 to $400. He views Netflix’s dynamics as a “mixed bag,” citing Neumann’s comments and the recent departure of advertising president Jeremi Gorman and the promotion of Amy Reinhard.

But Farrell said a potential price increase on Netflix’s ad-free plans could help support revenue growth, and that paid sharing will “continue to be a tailwind for subscribers in the near-term.” Piper Sandler recommended that investors remain on the sidelines until “we have more clarity on the story into next year.”

Netflix began alerting customers in May that its password-sharing days were over. Under the new policy, account holders can transfer a profile of someone outside of their household so the person can begin a new membership they pay for on their own. Or they can pay an extra $7.99 a month to add more people outside of the household.

On the earnings call, Farrell will be looking for progress on the paid sharing rollout, a timeline for when the ad tier will transition from “crawl to walk” and what the company’s new cadence of margin expansion will be over the next several years.

UBS analyst John Hodulik, who maintained a buy rating on Netflix stock but cut the firm’s price target from $525 to $500, expects its third quarter results to be largely in line with expectations, with the firm estimating six million net adds and revenue growth of 8.2%.

Hodulik lowered estimates for 2024, driven by a more gradual build of the ad tier and “more measured” margin expansion due to its investment in content and other growth areas. “Longer term, we still see strong operating leverage, especially as peers pull back on spend,” Hodulik wrote.

UBS anticipates 6% revenue growth and 14% EBIT growth in 2023, and 14% revenue growth and 29% EBIT growth in 2024. It also expects free cash flow of $5.3 billion and $15 billion in content spend in 2023, and $5.7 billion and $18 billion of content spend in 2024.

MoffettNathanson, which maintains a neutral rating on Netflix stock, cut its price target from $380 to $325, saying that “the opportunity to convert the 100 million global password-sharing accounts into revenue-generating users has led to a wide-ranging debate about future growth, with opinions ranging from large to very large (count us in the former camp).”

Out of the 30 million North American password-sharing users facing Netflix’s crackdown, about 22% to 32% of them would be willing to become new paying subscribers — amounting to 6 to 9 million additional subscribers, according to a survey of 19,000 Americans ages 18 and older by the firm and Publisher’s Clearing House. If Netflix is able to entice 25% of current sharers to resubscribe to their ad-tier, that would translate to 6.8 million net adds and $567 million in incremental annual subscription revenue, MoffettNathanson added.

The cautious comments from management led MoffettNathason’s analysts to significantly reduce their long-term outlook for Netflix.

The firm trimmed its revenue estimates for Netflix by 2% for 2023, 2024, and 2025 to $33.29 billion, $36.68 billion and $39.45 billion, respectively. Meanwhile, the firm cut its 2026 revenue estimate by 4% to $41.7 billion and its 2027 revenue estimate by 5% to $44.57 billion. It also lowered its earnings-per-share estimate to $11.55 in 2023 (down 5%), $13.50 in 2024 (down 9%), $16.40 in 2024 (down 10%), $18.30 in 2026 (down 15%) and $21.05 in 2027 (down 17%)

Wells Fargo analyst Steve Cahall cut his price target from $500 to $460 but maintained an overweight rating on Netflix stock.

The streamer “will be investing in ad tech and content, which will reduce margin expansion but also accelerate revenue,” he wrote in an Oct. 12 note titled Resetting Expectations. “We think long-term investors should buy any post-earnings weakness.”

The firm cut 2023, 2024 and 2025 earnings per share estimates by 2%, 5% and 9%, respectively. But Cahall predicted that underlying price increases will accelerate revenue 15% percent year-over-year in 2024 and average revenue per member by 6% year-over-year.

“As the investments bear fruit, our out-year estimates move higher,” he added.

While Cahall expects the recent appointment of Amy Reinhard as Netflix’s new advertising president to “improve operational decision-making,” he believes the company “has a ways to go” with the offering.

“We think investors would like to see more aggressive pushing of ad-supported tiers to accelerate scale and ultimately revenue,” he added.

Cahall believes that Netflix could invest roughly $300 million into ad tech overhead in the near-term as the ad-supported tier scales in the U.S. and Canada, and $900 million over time as it expands globally to reduce margin expansion and accelerate revenue. He also sees an opportunity for Netflix to benefit from content licensing, with the success of “Suits” on Netflix “marking a paradigm shift that reinforces how much more valuable library can be on the leading platform.” HBO library titles, “Friends” and even Disney content come to market, he said.

Cahall cut Wells Fargo’s 2023 estimate for how much Netflix would spend on content to $13.4 billion and upped its free cash flow estimate to $6.9 billion on the Hollywood strikes.

Wedbush Securities marked an exception to its Wall Street peers, with analyst Michael Pachter reiterating his outperform rating, $525 stock price target and Best Ideas List designation on Netflix stock in an Oct. 6 note to clients.

The firm expects Netflix to report earnings per share of $3.52, revenue of $8.52 billion and 5.5 million net subscriber adds. It cited the password-sharing crackdown as leading to strong account growth.

Pachter predicted that Netflix’s ad tier could be accretive to the company by the end of the year, estimating it could eventually generate $10 per month per subscriber in ad revenues, or higher, over time. He anticipates ARPU will meaningfully rise in the fourth quarter as college students return to school and are outside the primary household of their Netflix account, and that earnings per share and free cash flow will move “meaningfully higher” as extra members are added at virtually no incremental cost.

In the second quarter of 2023, Netflix estimated that it would have free cash flow of at least $5 billion for the year, citing lower cash content spend due to the timing of production starts and the writers and actors strikes. While Pachter expects “marginally higher expenses” due to the strikes, he anticipates those expenses will be absorbed as Netflix’s profitability expands.

Pachter believes that Netflix is poised to generate “significantly more free cash flow than its guidance suggests,” noting that the company has “reached the right formula with its global content to balance costs and generate increasing profitability.”

“Netflix is well positioned in this murky environment as streamers are shifting strategy, and should be valued as an immensely profitable, slow-growth company,” Pachter added.

Pachter called the Writers Guild of America (WGA) resolution a “win-win situation,” noting that the $233 million, three-year contract beat the Alliance of Motion Picture Television Producers’ (AMPTP) initial offer of $86 million and has provisions that are “highly incentivized for big productions and big winners in terms of viewership.” He estimates total production costs for the studios will rise by less than 10%.

Despite the win for the WGA, Hollywood productions remain unable to fully scale back up as negotiations between SAG-AFTRA and the AMPTP broke down last week. At Screentime, Sarandos cited an added levy based on subscribers the actors guild proposed, saying that was a “bridge too far” compared to the studios’ original offer of a “success-based bonus.”

Pachter believes that Netflix has “more wiggle room than the other studios who are losing money at streaming when it comes to offering success-based residuals,” citing its profitability and free cash flow coming from the password-sharing crackdown.

Once the strikes are resolved “Netflix will be best-positioned to bid for the best content and book the best talent for produced content,” he said. “In our view, Netflix’s deep content library and pipeline can be spread out thinly without driving increased churn … we expect the company to increase the mix of foreign produced content until domestic production and availability normalizes.”

Netflix shares are up 22% year to date and 47.2% in the past year as of Monday’s closing price of $360.82.

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