Thoughts on Netflix Q4 2022 earnings

Given that most people seem to focus on the Netflix subscriber acquisition number which was strong, I would like to highlight a few things that caught my eye.

Netflix Gross Margins

The gross margins are trending downwards and whilst the Q4 gross margin seems to always be much lower it is still trending lower by as much as 5-6 percentage points during 2022. According to Netflix it is due to the strong US Dollar. It is likely a contributing factor as there was a big hit on ARPU in EMEA and APAC. I think it is likely due to a combination of currency and ARPU mix. People are shifting tiers. It is still unknown what the impact of the AVOD business will be on margins but as I wrote before it will not be positive due to price competition on online video advertising in the market. We are likely to see a sliding ARPU in 2023. Netflix will still be the highest ARPU service in the market so whilst the results are not great, they are still going to outperform the rest of the competition on ARPU by a far margin.

Marketing costs

It remains to be seen whether this is purely seasonal or not or whether we will see a higher spending in general to maintain subscriber acquisition levels that they communicated to the market. The marketing cost compared to the amount of new subscribers was still really good. It will be interesting to see if we can compare this number to other players such as Disney, HBO, Amazon, Apple, Paramount and Peacock etc. I think they are likely going to be hidden by the others as they are likely much worse than Netflix' numbers.

Debt and interest rates

Debt remains pretty constant at 14 BUSD. There were no interest charges during 2022. I am not familiar with how this gets paid but it would be interesting to know what the cost of funding is and whether this is fixed or not. On 14 BUSD, having an interest which would be 150 points higher than the current 2 year US treasury rate is not unreasonable. It would mean interest rate costs (without amortisation) of at least 800 MUSD per year or around 14% of their current Operating Income of 2022. This is not insignificant and it could be much worse depending on what type of debt they have.

Conclusion and outlook

Whilst this article might seem a bit negative it shall be compared to the current realities in the market. For the record, this article are my own opinions and I am not a market analyst so take this for what it is. I am merely trying to highlight the risks and strengths I see in the Netflix numbers to give some information to potential and current investors for them to make qualified assessments on whether they think they should invest given the current climate. The macro environment is the big risk I see with the current valuation of Netflix. Rising interest rates, unfavourable USD and a hyper competitive market including also price erosion of online advertising are all components that make it difficult to navigate to achieve the current market expectations for 2023. Netflix current P/E ratio is 28 and whilst this traditionally has not been a high valuation I think given what I have seen from them and the challenges ahead I think it may be difficult for Netflix to reach their 2023 forecast. Compared to Microsoft, Alphabet for instance all have lower P/E with similar growths and in my mind much more diversified and solid businesses that can weather a tougher market much better than Netflix which has to rely on a consumer business in a hyper competitive sector. That said, Netflix' competition on average is likely going to post really bad numbers (Disney included) and debt funded smaller new ventures are likely going to have to call it a day. We are living in very interesting times and more than ever cash flow positive and high margin companies are those that are going to have significant opportunities ahead especially since money is not "free" anymore and likely will not be for a very long time. As always, I appreciate your thoughts and comments on this.