Netflix Inc.'s (NFLX, Financial) stock is down 46% this year, so it would be reasonable to conclude that 2022 was a painful year for the streaming giant’s shareholders.
The stock plummeted along with the broad market sell-off as rising prices forced many households to cut back on non-essential spending. The company, which has dominated the video-on-demand entertainment market for more than a decade, has also been hit with rising competition from new streaming services.
The company also recorded a decline in subscription growth, which was inevitable given the unexpected pandemic-related surge in 2020 and 2021. Netflix began 2022 with its first subscriber losses in a decade, citing a 200,000-subscriber loss in the first quarter, after which its stock dropped over 40%. The company attributed the slowdown primarily to increased competition in the streaming industry, the impact of the Russia-Ukraine war and people sharing passwords.
Even though Netflix is one of the world's leading streaming media companies, it claims the password-sharing model is impeding its growth in the current economic environment. The company noted that 100 million homes use its services but do not pay for them, accounting for approximately half of its global paid membership base. Account sharing was beneficial in terms of expanding brand visibility, but has now become a massive obstacle to growth.
Despite all these challenges, Netflix still appears to be an excellent long-term possibility for growth-oriented investors with an extensive investment time horizon.
Netflix rolls out advertising
On Oct. 18, the company reported third-quarter financials that exceeded analysts' revenue and earnings projections. Netflix recorded earnings per share of $3.10, which was higher than the $2.13 expected by analysts. Revenue grew 6% year over year to $7.93 billion.
Operating income, on the other hand, declined 13% to $1.53 billion, owing to the strength of the U.S. dollar relative to international currencies.
Netflix had a solid third quarter, particularly because the company added 2.4 million subscribers, more than twice the increases projected in the previous quarter and ending its two-quarter streak of subscriber losses. The company’s total worldwide subscribers stood at 223.09 million.
Despite stable membership growth, however, Netflix's revenue growth has slowed. The company attributes the slowdown to lower revenue per subscriber in international regions and slower growth in the U.S. and Canada.
The Asia-Pacific region accounted for the largest subscriber growth, bringing in 1.43 million new subscribers. Europe, the Middle East and Africa accounted for 600,000 net subscribers and Latin America scored 300,000 new users. The U.S.-Canada region accounted for the smallest increase, adding only 100,000 net subscribers. Furthermore, due to the impact of the rising dollar on its international revenue, the company forecasts fourth-quarter revenue will climb less than 1% year over year and decrease roughly 2% sequentially to $7.78 billion.
While subscriber losses were concerning, this negative development pushed Netflix to restructure its business with a focus on profit maximization, which speaks well for the company's future. The company said it would crack down on shared passwords and offer a lower-cost option with advertising to attract new users. Netflix launched an ad-supported subscription option on Nov. 3 in 12 regions. To stabilize its revenue growth, Netflix is rolling out its cheaper "Basic with Ads" tier aggressively, which costs $6.99 per month. Advertisers can show 15 and 30-second ads before and during programs, with a maximum of four to five ads per hour. Additionally, the new ad-supported tier will only offer video quality up to 720 pixels and will not allow users to download titles.
The company anticipates the ad-supported tier will attract 500,000 subscribers by the end of the year. Netflix also expects infrastructure investments in its new ad-supported tier to lower its operating margin to 4.2% in the fourth quarter.
Furthermore, beginning in 2023, the company will charge consumers to add additional homes to their subscriptions and shared accounts. A Netflix account holder can currently add up to five profiles to their account, which will become paid sub-accounts beginning in early 2023, as revealed in October. The concept has already been implemented in Argentina, the Dominican Republic, Honduras, El Salvador and Guatemala, with consumers required to pay an additional $2.99 per month to add more homes to their accounts. Netflix will begin rolling out these features widely in early 2023, with prices varying based on the region.
Expanding into new categories
With acquisitions and collaborations, Netflix has extended its gaming operations over the last year as well.
The company has partnered with major gaming developers to create mobile gaming versions of its popular franchises. Netflix also acquired Spry Fox, an independent gaming studio, in November, making it the company's sixth in-house gaming studio. Spry Fox was founded in 2010 and is known for games such as "Triple Town," "Alphabear" and "Cozy Grove."
Furthermore, Netflix is considering entering the burgeoning cloud gaming business. In October, the company announced plans to establish a new gaming internal studio in Southern California to accelerate game development. Netflix currently has 35 available games and 14 in development.
Takeaway
Netflix has had a challenging year, with the company currently under pressure as it implements service changes.
The company is on the right path to diversifying its products through anticipated password crackdowns, the rollout of lower-cost ad-supported plans and the expansion of its gaming segment. These developments will improve revenue per subscriber in the future and diversify its earnings streams.
However, it will take time to realize major returns from these restructuring efforts, which is why Netflix's stock should be considered by investors with a long investment time horizon. The company is finally turning a corner by prioritizing profitability over revenue growth, which should help investors gain attractive investment returns in the long run.
