Netflix (NASDAQ: NFLX), the streaming giant, recently released its Q4 2022 results, reporting revenue of $7.9 billion, up just 1.9% year over year, but FX was a significant headwind. On a FX neutral basis, the company reported 10% revenue growth. Net subscriber growth was 7.7 million, representing a 4% year-over-year growth, but significantly higher than the forecast provided by the company along with their Q3 earnings.  Netflix’s operating income came  in at $550 million, for an operating margin of 7%, down from 8% a year ago.

The most notable development in the shareholder letter was the stepping down of co-founder Reed Hastings from the co-CEO role. Hastings moved on to become Executive Chairman. The naming of Greg Peters as co-CEO alongside Ted Sarandos was also a surprise and somewhat baffling. Why does Netflix need two heads to run the show? 

It’s possible that this move was made to retain Peters in the company. Hastings isn’t exactly going away as he indicated remaining in the executive chairman role for “years” but this certainly marks the end of an era. Since its IPO, Netflix has delivered in excess of 28,000% gains, and Hastings’ record as a founder will likely remain the envy of many for a long time to come.

The question for Netflix as a business is its road ahead. Netflix’s shareholder letter once again reminded us that their long-term objective remains unchanged: “sustain double digit revenue growth, expand operating margin and deliver growing positive free cash flow.” In 2023, they expect to further refine their recently launched lowest price ad-supported subscription tier. With respect to their ads business they noted the following:

We believe branded television advertising is a substantial long term incremental revenue and profit opportunity for Netflix, and our ability to stand up this business in six months underscores our commitment both to give members more choice and to reaccelerate our growth.

There were some encouraging comments such as:

Engagement, which is consistent with members on comparable ad-free plans, is better than what we had expected and we believe the lower price point is driving incremental membership growth. Also, as expected, we’ve seen very little switching from other plans. Overall the reaction to this launch from both consumers and advertisers has confirmed our belief that our ad-supported plan has strong unit economics (at minimum, in-line with or better than the comparable ad-free plan) and will generate incremental revenue and profit, though the impact on 2023 will be modest given that this will build slowly over time.

Additionally, the company plans to launch “paid sharing” to tackle the issue of multiple households sharing one Netflix account. They believe sharing is widespread at 100+ million households! This could provide a potential source of revenue growth, but it remains to be seen how successful this approach will be.

In terms of longer-term opportunity, Netflix highlights its potential in the global streaming market, which is estimated to be worth $300 billion, as well as the $180 billion in branded TV advertising spend and $130 billion in consumer spend on gaming. When juxtaposed against the company’s $30 billion annual run rate, the opportunity appears large. However, it’s worth noting that the streaming market is becoming increasingly competitive, with many new players entering the space, which could make it difficult for Netflix to maintain its current level of dominance and take market share. 

Furthermore, when considering market share, especially in the context of the highly lucrative US and Canada market, as well as the EMEA market, Netflix’s argument that it is less than 10% of TV screen time in these markets may not be as significant as it seems. Sure, Netflix might be less than 10% of TV screen time in the US, but in terms of subscriber saturation, it is already highly penetrated in that market. More screen time (“engagement”) won’t translate into more subscribers, although it might offer benefits such as potentially lower churn and the ability to pass on price increases. 

This brings me to Netflix’s current valuation. As a more mature business, the days of heady growth appear to be behind it. Is Netflix’s $160 billion enterprise value, which is trading at an EV/FCF of over 100, justifiable given the headwinds and challenges the company faces in the future? Only time will tell if Messrs Sarandos and Peters are able to deliver for shareholders.

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