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Netflix earnings show ‘the game has changed’ for the streaming giant, analyst says

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Santosh Rao, head of research at Manhattan Venture Partners, discusses Netflix's earnings results and what it means for the streaming industry going forward.

Video Transcript

- Let's take a look at Netflix shares, rallying here after hours. The stock up just about 6 and 1/2%. The company reporting a narrower than expected loss here in subscribers. 970,000 subscribers lost during the second quarter.

The estimate out there was for a loss of 2 million. Revenue coming in at $7.97 billion. The estimate was for $8.04 billion. The guidance for the third quarter also coming in a bit light on the revenue front. Let's talk about this with Santosh Rao. He is Manhattan Venture Partners' head of research. Santosh, it's good to see you.

SANTOSH RAO: Good to be here. Thank you.

- So a narrower than expected loss. 970,000 subscribers lost. And still almost a million subscribers that Netflix has lost over the last three months. How are you looking at today's report?

SANTOSH RAO: Yeah, I think this is a good report. It was all about-- well, it was not necessarily all about subscribers. The company wants to move away with the net subscriber adds. But I think this one was important because the whole issue was, are they losing their game? Are they losing their market share?

And the fact that the losses were less, that's a net positive. It's very good. They're trending correctly. Let's see what they say about the next quarter.

But overall, I think it's trending correctly. The revenue is OK. It's slightly off. The estimate was $1.2 billion-- actually, $8. Sorry, $8 to $8.1. They came at $7.97. That's OK.

And the loss-- the EPS is also-- in fact, EPS was better than what the consensus was. So I think net net, I would say this is a good report. They're on the right track.

They just need to continue building. It's in the rebuilding phase. The competition is different. The competitive landscape has changed. The game has changed.

They need to regroup, restrategize. And they're doing it correctly, it looks like, with this net subscriber losses much better than what was expected.

- Santosh, you're describing a good report. I'm seeing it's the first time ever Netflix has lost subscribers in back to back quarters. That doesn't feel like a good trend. How do they stop the bleeding?

SANTOSH RAO: Yeah, I think what they have to do is continue delivering on the content, premium content, which they will. And see, I think we have to be we cannot compare it to the past. Things are different now. The landscape is different.

There are much-- many more players out there. The addressable market or the subscriber base-- the potential, the pool of base potential base is going to be scattered with the competitors. But over the long haul, probably a year or two, I think the dust will settle. And the big winners will come ahead.

And I think Netflix, being the incumbent leader, a global leader with $224 million subscribers worldwide, the broad global footprint, I think they have a good lead on others. They are profitable. They can do it.

I think in terms of what they need to do is just continue to execute, control their costs, but continue delivering premium content, which I think they will continue to do. I think that's the key.

- And then-- and in terms of growth factors, we know they're obviously looking at the subscriber net additions. Used to be the most important thing. But as you mentioned, this is a more crowded space now. Where should Netflix be looking to see the next level of growth?

SANTOSH RAO: Yeah, in terms of geography, I think internationally is, again, the big-- big growth factor. That's been incremental. Growth is going to come. North America is pretty much saturated. But-- but they have raised the prices. And I think the revenue number will go up.

But overall, in terms of quality, I think they are looking at more increasing the engagement level and increasing profitability. And this just delivering on the value proposition. I think that's the key right now because there is a little bit of hitting the wall in terms of adding incremental customers, especially in the lucrative markets of North America and maybe even EMEA. But I think overall, they need to continue adding-- Asia-Pacific, Latin America.

They need to continue growing. And just like I said, just premium content. They have the lead. It's their market share to lose.

But they-- ultimately, everybody wants to be Netflix. That's why they're getting-- they're losing money. They're investing a lot. Netflix already has a base. They just need to continue delivering and differentiating themselves with good content.

- Santosh, our media reporter, Ali Canal, when she was breaking the numbers-- two things that she said she was curious in the earnings call that's going to be getting underway in just a few minutes was, one, why Netflix picked Microsoft to be its partner on that ad-supported tier and, two, what the timeline looks like for the rollout of the ad-supported tier?

What do you think is a realistic timeline? And what do you make of Netflix's decision to partner with Microsoft?

SANTOSH RAO: Yeah. I think it's a very good decision. In terms of the rollout timeline, I think it's going to be end of the year or early next year. I think the company management has said that in one of the conference calls-- in one of the conferences, rather. So I think that's going to be a little later.

And it's going to be a kind of a staggered rollout. It's going to be a gradual rollout. You're not going to see the impact immediately. But I think as they roll out next year.

But Microsoft as a partner is a very good deal. You're getting one of the good players out there. It's going to be exclusively available through their platform. And then down the road, they can have a more holistic relationship with Microsoft in terms of cloud and gaming initiatives that Netflix may have down the road.

So I think it's a big-- good partnership down the road. And don't forget, Netflix was also instrumental in building Facebook's ad business in the beginning early days of their life. So I think they have a presence there. And there's a strong company out there and one of the good ones out there.

So I think this relationship makes total sense. And it'll bear fruit.

- You know, I know you're on the phone. You may not see the video of have rolling. But Santosh, it is a reminder. You go back to "Squid Game," "Bridgerton" season two, and "Stranger Things" four. They have the three biggest hits by a country mile over the last year, which is a reminder, in this environment, they are still the king.

In a letter to investors Tuesday, they said, quote, "Our challenge and opportunity is to accelerate our revenue and membership growth." Now, membership growth-- it's not entirely clear how the password sharing policy will impact that. But certainly it will on the revenue side.

100 million are estimated to be sharing passwords. And the word is we're talking about $2.99 a charge for password sharing. How significant a revenue generator will that be? And when will it come here?

SANTOSH RAO: Yeah. Yeah, I didn't even go into that. I think their ad-based model that they're introducing and the revenue and the password sharing that they're going to discontinue-- or not allow, rather. And that's going to be incremental revenue.

We'll have to wait and see. I'm sure they're going to lose a few customers because they have to pay extra for price-- password sharing. But ultimately, I think net net, I think I-- we expect at least 4 to 5 million new customers coming in. I mean, it's tough to say at this point. But there will be an incremental add to their user base.

The cost-- the big risk is they don't want to cannibalize their premium base that pays close to $15 bucks a month for standard. So I think that they need to really be careful about that. But there's a whole bunch of in their big base-- there are people who may not want to or who would like to pay less and still be on the platform.

So I think add-based model makes sense for a lot of them. So I think overall I think it's a good deal. I don't know the exact number, how much incremental. But it'll definitely be incremental to the whole thing.

At this point, you know, I think I'm looking at maybe extra $10 million or something in terms of revenue addition to the base initially and then keep growing. But it will be net additive overall. It's not an easy business, by the way.

It'll take some time. They're still working on it. It's going to be rolled out. But they needed that they needed a backstop for people who don't want to pay premium but-- but really don't mind paying a lower fee for the inconvenience-- inconvenience of having ads.

So I think you're going to have that mix, which is a good mix. And net net, I think they will be able to maintain the RPU level at a relatively high level that they have right now.

- And, Santosh, what would you say will be Netflix's main edge over the competitors-- over a Disney Plus, over an Apple TV? What might give Netflix an edge in this space?

SANTOSH RAO: Yeah, I think right now I would say it's they have the mindshare and market share. I think that's one thing to begin with. I think it's just the content. It's the-- streaming has become so commoditized so at this point. It's easy to get in and get out so easily.

So the main thing is to have their high engagement level, have that stickiness. And I think they have that. And they have across genres and across demographic groups. I think that's a big thing.

Disney may be just for the-- I mean, they're more selective in what their target audience is, though they're expanding and growing. Everyone is kind of positioning themselves. So it's really a work in progress for everyone.

But Netflix is already there. It's been delivering. So they just need to build on their lead and kind of continue hammering away and just kind of get back their glory days of the past, when they were the only game in town. So at least try to be one of the top one or two players out there.

And I think they can get there with the competitive lead that they have, not just here, globally too with the localized content in the international markets. That's a big hit out there. And so I think they have a lot of good points out there. Others are mainly domestic, just kind of expanding a little bit. But Netflix has a global presence. And I think they can maintain their competitive lead.