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What to expect from Netflix earnings

Tuna Amobi, CFRA Analyst breaks down what investors should expect to see when NFLX reports earnings after the bell.

Video Transcript

ADAM SHAPIRO: Looking ahead to other earnings we're going to get, Tuna Amobi is joining us. He is the CFRA Analyst joining us from Maplewood, New Jersey, to talk about Netflix. Tuna, I'm really upset, because I've already watched all the episodes of "Ozark" and "Schitt's Creek," and I'm one of those people already signed up for Netflix. Are they going to be able to keep signing people up or have they peaked out?

TUNA AMOBI: Well, thanks, Adam. It just tells you kind of the new world order that we're living in now, with so many limited entertainment options in this time of COVID. But to your core question, I think coming into this third quarter, I think expectations for Netflix have been relatively tempered coming off of the gangbuster first half addition of 26 million global subscribers. So we know that the COVID-19 demand tailwinds are still in place for Netflix.

The biggest question is, how much of that performance that we saw in the first half could represent a pull forward of demand for the third quarter and for the fourth quarter, which we expect to be a factor? But more importantly, there's been some backlash. You probably heard about the French drama, "Cuties," which I think there's definitely some headline risk involved in there in terms of potential churn. And that's the biggest question we have when you talk about the 2.5 million global net additions guidance.

Right now, expectations are all over the place. There's a very broad dispersion among analyst consensus estimates. We just happen to think that they'll come in slightly above that target, 2.5 million. That being said, there is definitely some risk to the downside here. But all in all, I think that third quarter is going to really present a litmus test of what to expect towards the last quarter of the year. The return of live sports, the intensifying streaming competition, all of those factors I think are things that we'll be watching for to see the potential impact it had on Q3, and more importantly, outlook for Q4.

JULIE HYMAN: Hey, Tuna, it's Julie here. What about the spending picture at Netflix? Because obviously, it's saving some money right now, because things are not in production. Are we likely to see a sort of balloon effect when things do start to pick back up? Or is Netflix going to be able to do some rationalization of the big spending that it's been doing over the past few years?

TUNA AMOBI: Yeah, that's a great question. We know that this year is going to present more or less a positive free cash flow anomaly for Netflix, largely because of the factor that you just mentioned, which is the fact that they have significantly dialed down their content spending, largely due to the COVID-19 disruption, when we saw a halt of TV and film production.

Now that has come back now and been ratcheted up. But for the most part, we still think that they are on track to generate meaningfully positive free cash flow this year. They had $1.5 billion for the first half of the year. We think that very well second half, while content spending has ratcheted back up, they will still end up nicely positive.

More importantly, I think investors are looking beyond this year, when next year I expect that they're going to revert back to negative free cash as they kind of ramp up their content spend again. But this is really consistent, Julie, with the expectations for a multi-year path to positive free cash flow, which we think largely remains intact. Talk about margins this year. We still feel that they'll deliver at least 300 to 400 basis points of operating margin expansion, which is another indicator that investors are keeping an eye on, which should also be sustainable going forward.

BRIAN CHEUNG: Hey, it's Brian Cheung here. So in summary, it seems like among all industries, the bar for earnings estimates have gotten higher. So is that the case for Netflix? And if that is the case, what is going to be the more important non-GAAP measure to beat that? Is if the subscriber growth numbers or is it the free cash flow numbers?

TUNA AMOBI: I think it's a combination of both, Brian. The subscriber growth has been awfully important, especially with so much upside left on the international growth. And also the addressable market, I would argue, has actually enlarged due to the dynamics of the COVID-19 stay at home. The question is, how much of an impact do other streaming entrants, whether it's Peacock or Disney+, how much of that is going to dent the overall pie, which I would argue has broadened.

So to your question, I do believe that free cash flow is going to be increasingly important over the next few years as the preferred yardstick. But for right now, I think subscriber growth is going to remain perhaps the singular most important metric that investors remain focused on for Netflix.