Netflix reported an underwhelming second quarter. After adding a record 37 million new subscribers in 2020 during COVID, the streaming service added less than 6 million new subscribers globally for the first half of the year. All eyes are now on the second half, where a stronger content slate is supposed to drive accelerating user growth, according to the management. However, the company's Q3 guidance of 3.5 million net adds was not enough to restore confidence in the user growth trajectory. Management also shared more information on the push into the gaming market. It appears that gaming will be "one of many elements that support the core product" and will not be a revenue generator by itself. The idea makes sense strategically, but we won't see any tangible impact for at least several quarters.

However, we remain optimistic for Netflix over the long run for three reasons:

• Low penetration: Internet streaming is still in its early days, and Netflix's share is still low and can grow. In the U.S., while Netflix's penetration in broadband households is well over 60%, it only grabs 7% of total T.V. streaming time. Globally, Netflix penetrated 20% of the 800-900 million broadband homes, with much less T.V. streaming time. It is great to see engagement on Netflix has gone up 20% since Q2'19, and we believe the company's effort in free gaming will only help improve user engagement.

• Low ARPU: Netflix is one of few companies that can raise prices consistently for two reasons. First, Netflix's price is still significantly lower than residential video ARPU in many countries. In the U.S., Netflix's ARPU is only 1/7th of Comcast's or Charter's ARPU. Second, the global streaming market is dominated by traditional U.S. networks (Disney, WarnerMedia, and ViacomCBS), an oligopoly structure that has historically avoided price competition.

ARPU: Netflix vs. Linear TVs ($)

Close

ARPU: Netflix vs. Linear TVs ($)

• Expanding margin to support buyback: Netflix still aims at a 3% annual increase in operating margin. In the long-term, Netflix's EBITDA margin is likely to reach 40% that cable companies enjoy for a) little depreciation on fixed assets and b) content amortization as a percentage of revenue will decrease as the company scales. Netflix has committed free cash flow to share repurchases. Buyback has been a trend among tech giants in the last few years and significantly improved shareholders' value. Apple and Alphabet's share prices went up 7x and 3.5x respectively since they initiated repurchases in 2012 and 2015, even as their growth slowed down.

Close