Why Netflix is down despite Q3 earnings beat

Yahoo Finance’s Julie Hyman, Brian Sozzi, and Brian Cheung break down Netflix’s Q3 earnings report, and outlook for the streaming landscape.

Video transcript

JULIE HYMAN: Netflix subscriber growth coming out and beating estimates. Yes, you've got the earnings per share. You've got revenue matching estimates. But of course, with Netflix, typically, the focus is squarely on subscriber growth. It came in at 4.38 million last quarter. That is better than estimated. Much of that growth-- pretty much all of that growth accounted for Asia and was accounted for in Asia and Europe.

Now, the company is forecasting an increase of 8 and 1/2 million subscribers in the fourth quarter. And yet-- and yet, Brian Sozzi, we are not seeing a very positive reaction to the numbers this morning.

BRIAN SOZZI: Yeah, sorry. "Squid Game" bulls. A couple of reasons why here I think, Julie, you can really boil it down to-- one, the net additions always a closely watched metric for Netflix followers and investors. 4.4 million, slightly below some of the whisper numbers out there, which were looking for about 4.6 million to 4.7 million. Obviously, the Street is not going to dig that one as well.

Also, the guidance for the fourth quarter on net additions-- looking at about-- about nine million or so. Actually, 8 and 1/2 million. The Street was looking for about 9.3 to 9.5 million. So some disappointment in that regard here.

But look, the bottom line is this. Good note out of Wells Fargo by Steven Cahall that really wraps up how investors, I think, should be thinking about this quarter outlook from Netflix, despite them guiding to an operating margin plunge in the fourth quarter because of higher costs. He says this, "the consistency of performance to deliver hits drive subs and revenues and grow earnings is undoubtedly worth a premium."

And Brian Cheung, you did get that sense from the earnings call last night on Netflix. This company is about to drop a serious amount of new hits on the market, not just for the fourth quarter but next year as well. And perhaps that will lead to re-accelerated growth for the company.

BRIAN CHEUNG: Yeah, absolutely. In fact, I think the earnings call actually began yesterday with the-- who was it, the CFO or one of the executives beginning with Annyeonghaseyo, which was the Korean for Hello, obviously alluding to the massive hit that "Squid Game" has been for Netflix. But it's really not just that title. "You" has been getting a lot of hits as well. And I think that's a big reason why a lot of the focus is going to shift to the fourth quarter instead of the third quarter that was just reported.

But I think maybe one reason why you're seeing this little bit of a lack-- lack of enthusiasm, if you will, in the pre market is because the net subscriber growth is just a lot slower than it was in 2020. And this brings up the broader point that I've been kind of talking about across industries, which is a lot of these comparisons are just so difficult when you're comparing it to the pandemic months of last year. But for Netflix, it's actually the opposite because 2020 was such a banner year for them.

I mean, in the first half of 2020-- again, covering the most of the beginning of the pandemic-- they had 25.9 million additions in terms of subscribers. If you compare that to the first and second quarters of this year in total, only 5.5 million net subscribers. And that's not a bad thing. And analysts understand that you're not going to have another 30 million additions because marginally, it becomes harder to add new net subscribers as you gain share. So I think that's going to be a story going forward.

What is interesting to me in the earnings call was that they're going to try to switch the metrics that they're emphasizing here. They actually want to emphasize reporting hours that were viewed for their shows as opposed to the number of accounts that are watching them. Obviously, this kind of fits in line with other thematic things that we've heard from Netflix about wanting to prioritize the quality of the viewer instead of the number of viewers as well. So this could be their pivot, if you will, for quarters to come.

BRIAN SOZZI: I'm making my way through "Squid Game", guys. I originally gave it 7 minutes. Up to the point now where they're trying to cut out--

BRIAN CHEUNG: Yeah.

BRIAN SOZZI: And I'm up to the point where they're trying to cut wafers out of, you know, out of-- or shapes out of wafers. So don't-- don't tell me anymore. But look, we have been talking about Disney on the show, really, for the past five sessions. The stock has come under pressure. It's been dead money since March, seeing analysts come out here downgrade Disney stock.

And if you're looking to play media and that transition to streaming, you have two choices here. It's really Disney and/or Netflix. And look what the stories are now. They're very different. You have Disney coming out saying their subscriber growth for Disney Plus-- their streaming content-- that is starting to slow. And you have Netflix on the other hand saying subscriber additions are starting to reaccelerate. You want to gravitate to a story like that, I think, Julie, as to oppose what Disney has been pitching since its Goldman conference presentation last month.

JULIE HYMAN: You know, I have to wonder at this point if investors aren't saying, we're not going to choose between them at all. We're just going to kind of let it ride, right? Because the stock is not-- is not rising this morning. That said, people have been buying Netflix over the past couple of months or so. We have seen an uptick in the stock. They're up-- the shares are up about 20%.

I like the commentary this morning from Truist Securities, which said, quote, "no big surprises. Not much to complain about." In other words, like, this quarter-- you know, if you were accustomed to a growth stock coming out every quarter and wowing and the company comes out and does well and executes what they're supposed to be doing, maybe you're just not going to see that big upside for the stock like you would if they came out with some sort of eye popping numbers.

And guys, remember there is also something else that is hanging over the company now. I don't think this has been much of a concern for shareholders, certainly, but the whole controversy over Dave Chappelle's special, "The Closer," is continuing to bedevil management. The co-CEO Ted Sarandos saying in an interview with Variety yesterday that he screwed up the internal communications and handling of the discussion of the Chappelle special. Today, there's due to be an employee walkout at Netflix.

And so, you know, even if that's not going to affect the big picture for the company subscriber growth, et cetera, if it's something that is perhaps distracting management at this time, maybe that's a little bit of an overhang.

BRIAN CHEUNG: Yeah, and that's definitely a good point worth bringing up, but I actually want to zoom in on the first point that you made about their financials. I mean, yes, it is indeed the case that we're at this inflection point with Netflix where it's not that they're really going to become a value stock. That's definitely not the case. But as a growth stock, you cannot expect to see 30 million subscribers every six months again. And I think that's something that investors are trying to deal with.

And also consider, look, at the end of the day, their scale is enormous, right? $7.5 billion in a single quarter. This is a massive company. We all know that. We all have friends and family that have Netflix accounts.

But the question is, on a free cash flow basis, this is still an extremely narrow organization when it comes to the margins, right? I mean, yes, I understand that they had blowout free cash flow in the first quarter of 2021 and in the third quarter of 2020. But they had, what, negative $100 million in cash flow just for this quarter?

I mean, the cost of content is such a big focus for Netflix. That's a big reason why a lot of people are looking at Google and Alphabet and saying YouTube has an enormous amount of following at a much cheaper cost. So I think that's going to be a focal point for a lot of people watching the media space in the future.

JULIE HYMAN: Yeah, that is a good point. We don't talk about YouTube often enough when we talk about all of this stuff.