The Update Issue: Anticlimactic Earnings for Netflix, The 30,000-Foot View for Streaming, Duolingo

By Berna Barshay

Thursday, October 21, 2021

► Streaming giant Netflix (NFLX) has been roaring into the headlines, but earnings made more of a whisper...

The buzz around Netflix has been overwhelming the past several weeks. The streamer has been in the news constantly due to its breakout Korean hit Squid Game and the controversy surrounding The Closer, the latest special from comedian Dave Chappelle.

It's said that "all PR is good PR," although I think Netflix execs might disagree when it comes to the Chappelle discussion. But the noise has certainly driven viewers to check out what all the fuss is about, pushing The Closer into the Netflix top 10 most-watched U.S. programs. Maybe the old saying is right after all...

Turning to Squid Game, all the media hype turned out to be well-deserved as Netflix revealed in its earnings release that an astonishing 142 million accounts watched the violent and politically incisive series in the first four weeks after its premiere in mid-September.

This is incredible on several levels...

First, it breaks the record set by the romantic and soapy Bridgerton, which premiered on Christmas in 2020. That show racked up 82 million viewers in four weeks... This means that Squid Game not only bested the prior record by 73%, but it did so at a time when the world was reopened, and there was more competition for free time with people no longer stuck at home.

It also did it at a time when fewer people were on vacation with time to stream. The weather is also much better in September and October than in December in January for subscribers in the Northern Hemisphere – which is the majority of them. People tend to stream more in bad weather – yet another thing making the jump in performance from Bridgerton to Squid Game incredible.

Another impressive thing to consider... Netflix has about 214 million paid subscribers. This means that a whopping two-thirds of paid subscribers tuned into Squid Game during its first four weeks.

Now, it's important to remember that Netflix counts a subscriber as a viewer if he watches just two minutes of the show. That's a low bar, but it is apples to apples with how it measured Bridgerton and other past hits, so we know Squid Game was truly an off-the-charts outperformer for the company.

Discussion of Squid Game dominated much of the call... and management was just a little excited by it, as evidenced by the fact that Netflix co-founder and co-CEO Reed Hastings (as well as Investor Relations head Spencer Wang) sported the iconic green tracksuits from the show on the video presentation...

The costumes that these two executives wore on the call are clearly foreshadowing the onslaught of Squid Game-branded consumer merchandise that is on the way to stores now, as teased by management on the call. Netflix has aspired to get deeper into consumer products for some time, and this show will probably help it along in this effort.

Despite the success on the content front, earnings were more of a mixed bag...

While Netflix did handily beat earnings forecasts posting $3.19 in earnings per share ("EPS") versus expectations of $2.56, shares sold off about 2% yesterday. They are rebounding today but sit near where they were before the earnings release.

While net subscriber additions of 4.4 million did beat management's guidance of 3.5 million last quarter, it's a relatively small beat given the magnitude of the hype around Squid Game.

Also, it's important to remember that management's guidance of 3.5 million net adds for the third quarter was below analyst expectations at the time... so these third-quarter subscriber results are generally in-line with what people were expecting midyear until they were told to expect less.

But the stock is much higher than it was midyear.

NFLX shares had already gone on a tear in September and early October...

The first leg of that move was likely investors reacting to the announcement of price increases in dozens of countries. The second leg was due to Squid Game.

After having put in a 12% move from the beginning of September to the time of the earnings report, the 25% EPS beat and 26% subscriber beat weren't enough to keep the stock going... at least not when combined with some of the less bullish aspects of the quarter...

While Netflix added a healthy 2.2 million subscribers in the Asia Pacific region and a robust 1.8 million in Europe, the Middle East, and Africa ("EMEA"), it only added 70,000 net subs in the U.S. and Canada, despite having lost 430,000 subscribers in the region last quarter.

Sub growth in Latin America was also slow at 330,000. When asked about it on the call, management noted an expected pick up in churn (subs quitting) when they took price increases in Brazil during the quarter. Because the future growth at Netflix rests on its ability to grow subscribers internationally – and eventually get the ones that are paying very little for the service to pay more – how quickly the Latin American numbers bounce back up will be key to watch.

Putting it all together, Netflix executed extremely well in the quarter and had good results – including great operating margin expansion – but it seems the setup wasn't great as expectations were too high due to the Squid Game hype.

What Netflix has accomplished here in creating a truly global hit is simply incredible...

As I wrote about last week, this global triumph is the result of years of investment and forward-thinking. Netflix had two great insights when it chose to invest so much in international.

First, it realized early in the game that international success would be critical when it really didn't have much streaming competition. To win international subscribers, it would need compelling local content. Local content means not only local language but also local themes, stories, and characters, written and produced by locals.

The second great insight was that great stories are universal, and great filmed content will travel. In committing to this, it bucked conventional Hollywood wisdom.

Netflix earnings this quarter illustrate an important investment lesson... Sometimes company performance and stock performance diverge. You can have a good company and a bad stock, or vice versa.

Netflix is a stellar company. The visionary foresight to invest in international as it has is incredible. But the stock is at peak valuations, there is a risk of heightened churn in the fourth quarter from all these price increases, and the U.S. and Canada – which have some of the highest prices for the service – seem to be bumping up against a subscriber ceiling.

For these reasons, I am staying on the sidelines with NFLX shares, but I remain in awe of what it's doing. Amazing company, so-so stock up in the mid-$600s.

This one graphic from the Netflix quarterly presentation was interesting vis-à-vis the broader streaming universe...

Source: Netflix

Two big takeaways for me here... First, this is a great reminder that we are still in the early days of streaming. There is a lot of growth to come, as I think people will continue to migrate to cord-cutting and nonlinear viewing. Once you start binging shows and watching on your own schedule, it's addictive.

Second, the lead in viewing time that Netflix and Alphabet's (GOOGL) YouTube have is considerable. It's amazing how tiny the share of Hulu, Amazon (AMZN) Prime Video, and Disney+ (DIS) is... and there are so many players that don't even show up on this pie chart, including Comcast's (CMCSA) Peacock, ViacomCBS' (VIAC) Paramount+, Apple TV+ (AAPL), and Discovery+ (DISCA).

I noticed something interesting on the corporate blog of language-learning app Duolingo (DUOL)...

I'm a big Duolingo user – I am currently brushing up on my French and Spanish and making a woeful attempt to learn Danish on the app (it's hard!). I wrote about the company back in July when it had its initial public offering ("IPO"). It's a great app, but the stock is a little richly valued for my taste... but I like to keep an eye on it.

This post on the blog caught my eye...

Source: Duolingo

Squid Game launched on September 17, driving a staggering 40% increase in new learners studying Korean on the app in the latter part of September.

There's a second Korean-language series, My Name, sitting at No. 6 on the Netflix charts right now. Combine these two shows with the Duolingo data and the current popularity of K-pop music. There's no doubt the interest level of Americans in all things South Korean is spiking.

In the mailbag, some advice for job seekers, a reaction to the essay on interpolation in music, and thoughts on tax avoidance and evasion in the wake of the Pandora Papers...

For those of you who still watch a fair amount of broadcast or cable television – and some of you must, based on that pie chart – what do you watch? Sports... news... reality shows... scripted programming? What might tempt you to cut the cord? Have you used Duolingo or any of the other language-learning apps out there? Share your thoughts in an e-mail to [email protected].

"Hi Berna, I read Seth's comments on your newsletter yesterday about his troubles finding an internship. As a somewhat recent college grad that went through the same experience both with internships and post-graduation employment, I'd like to share a link that may help. I'm not currently in the job market, so have yet to utilize it, but if the feedback on the Reddit post is legitimate, it seems to have helped a great number of people. The advice and resume format comes from a longtime recruiter from your industry as well, so [it] should be helpful for Seth. You can either send it to him directly if allowed or publish this response if that's more appropriate.

"[In] addition, I agree that networking is indeed extremely helpful for job/internship searches. After struggling to find full-time employment after graduating, I was able to land a solid job through a former classmate.

"All the best," – Roland D.

Berna comment: Roland, thanks for sharing the link and your experiences.

"Yes, I do consume more music than I ever did. No, this 'interpolation' isn't creative, and it probably isn't a moneymaker either. The Internet has made music very niche and very fragmented. It is also the 'soundtrack' of a person's life. What does it say when one's soundtrack is recycled from other people's lifetimes? Not writing your own original music is like being unable to perform your music live or having someone else do your guitar solos.

"What's worse... this 'interpolation' is not well-hidden, to the point where I suspect someone is leaking these interpolations. An Ava Max listener is not going to be a Bon Jovi listener, and vice versa. Who then could spot the similarity? I suspect the original owners will leak the connection and then maneuver to take the song. See 'Bittersweet Symphony.' – O.P.

Berna comment: It is actually a moneymaker... because artists are increasingly seeking permission and sharing the credit (and royalties) for the composition. They are giving up some revenue, but I guess they choose to do that because it allows them to write songs faster and get a better hit rate with them. That's the money side of it all... the legitimacy of this from an artistic standpoint is more up for debate.

"This is no big revelation. Everyone has known for years where and how the rich hide their money. Back in the 80s, I used to work for a company that was on the Universal lot called the Arthur Company. It was no secret that the owner of the company took monthly or bimonthly trips to the Cayman Islands as Universal was using the Arthur company to hide millions of dollars of profits from their movies.

"The only real revelation is that these journalists are just as bad - only instead of hiding money, they're hiding American elites because that fits their corrupt narrative. You really believe that ultra-billionaires like Gates and Bezos, and Musk aren't hiding their money as well? Don't be naive. Aren't you at least a little suspicious when not one American is named?" – Rick R.

Berna comment: Rick, my takeaway was that maybe the Americans are more adept at hiding the money.

"Hello Berna: Tax avoidance is perfectly legal and is codified by law. Tax evasion is illegal and subject to criminal prosecution.

"If avoidance tactics are bad, then the law should be changed. Blame the elected officials for not doing so, especially those who have held office for what seems like forever and a day. These officials had the power to remove these avoidance tactics and failed to get them changed.

"All of our laws should be enforced equally and without discriminating on whether you are rich or poor. Administration after administration decides on what laws to enforce and which ones to turn a blind eye. If an elected leader does not like a particular law, then change the law. Do not create executive orders to make laws without the legislative process, which is then no better than dictators like Putin and many others.

"Thank you." – Steve O.


Berna Barshay
October 21, 2021

Whitney Tilson

Get Empire Financial Daily delivered straight to your inbox.

About Berna

Berna Barshay is editor of Empire Financial Daily and a contributing editor to the Empire Stock Investor and Empire Investment Report newsletters.

She graduated cum laude from Princeton University and earned her MBA from Harvard Business School in 1997.

Following her graduation, Barshay spent 20 years on Wall Street. She began her career in equity derivatives at Goldman Sachs and later worked as a buy-side equity analyst at Sanford Bernstein, where she covered global consumer cyclicals and conglomerates.

Later, Barshay spent five years working as a portfolio manager of the Ingleside Select Fund, a long/short fund with a focus on value and event-driven stocks. She later was a portfolio manager at Swiss Re, where she managed the Consumer long/short book on the equity proprietary trading desk.

She has additional experience as a buy-side analyst at several long/short hedge funds – including Sky Zone Capital, Metropolitan Capital, Buckingham Capital, and LaGrange Capital – where she primarily covered consumer and technology, media, and Internet stocks in the U.S. and Europe, with some additional work in financials and energy.

Barshay is a fashion enthusiast, a pop culture addict, obsessive indoor cycler, and prolific social media user. She currently lives in New York with her husband, daughter, and three dogs.