Netflix earnings preview: what investors should expect

Netflix is set to report its fourth quarter earnings results after the closing bell on Tuesday. CFRA Analyst Tuna Amobi and ARK Invest Analyst Nick Grous joins Yahoo Finance Live to weigh in.

Video Transcript

AKIKO FUJITA: Well, let's take a look at where shares of Netflix are trading right now, popping in the session, up nearly 2% ahead of earnings after the bell today. The streaming giant has seen huge gains throughout the pandemic, but how much of it can be sustained? Let's bring in our two guests on this. We've got Tuna Amobi, he's a CFRA analyst. We've also got Nick Grous, an analyst at ARK Invest.

And gentlemen, it's good to have both of you on today. We've got 195 million subscribers going into the quarter, already double the number of Disney, I think, and six million new expected. So let's start on the flip side. What's the risk, what's the concern as we look ahead to this report after the bell? Tuna, first to you.

TUNA AMOBI: Akiko, good-- good afternoon, and thanks for having me. Look, I think as we kind of think about the quarter, you know, there's a number of things, right? They're coming off of a price increase in the US, as well as some international markets. The competition has, obviously, gotten more intense in the streaming space with the new entrants, whether it's Peacock, HBO Max, Disney+.

And then we know that last first 1/2 of the year, they had this tremendous, gigantic net adds of 26 million, largely due to the COVID-19 demand tailwinds. So the big question here is, how much of that is a pull forward that we should expect in this Q4? We saw some of that pull forward impact in Q3 where the net adds were relatively subdued. Our guess is that they're going to come in slightly north of the six million net add guidance, which the company is looking for. But the bigger question is, looking ahead for-- for this first 1/2 of this year, the residual impact of that pull forward impact, which we talked about which we expect to be a factor as they give the Q1 guidance for this year.

But I think more importantly, we are squarely focused on the free cash flow profile. They're going to end the year in a positive free cash, right around $2 billion, which is a potential anomaly given the shutdown in Hollywood productions. But as we kind of cycle through the next few years, we think that they're going to kind of get back on the sustainable inflection. We expect in the next two or three years, we're going to have a positive free cash flow. So there are a number of risk factors relating to competition, price increase, subscriber churn and retention, but all in all, we think they're all relatively manageable from a medium to longer term perspective.

ZACK GUZMAN: Yeah, and Nick, I mean, when you think about the overall sector here, right, in the streaming business, you can still be paired and I guess judged against Disney's explosive growth year, but also be a winner as more and more people turn to this over traditional cable or TV. So talk to me about how that maybe matters when investors sit back and look at the relative opportunity here with Netflix.

NICK GROUS: Absolutely, we are still very much in the early innings of this streaming story. In our view, we see from the US side, there was roughly 86 million US households still tied to linear TV in 2019. We think that's going to come down by more than 50% over the next five years into 2025. We think we're at roughly 75 million today. So that's an 11 million decrease in linear TV subscribers, and all of that is flowing over to the streaming.

So you have this story in Netflix, in Disney+, in HBO Max on the subscription video on demand side. But another great opportunity here in streaming is ad-supported video on demand. And that is a space I think is still very much up for grabs. And there's plenty of ways to view that, but we're still very much in the early days of this story.

AKIKO FUJITA: Well, ad-supported video on demand, to your point, we were talking about that with an executive at Roku a few weeks ago. But Nick, I mean, where does that put Netflix when they're still running on a subscription model. Clearly, it's been lucrative for them so far. Is there a shift potentially that's coming?

NICK GROUS: I think, you know, they are very much going to be a subscription video on demand service for the near future. That's what management has always talked about, and that-- and that's fine. But again, you know, this segmentation is always going to be there in the market. It's what consumers want. Some don't mind advertising, some do.

So people are going to have both, right? There's not going to be a clear cut winner in the streaming space. There's going to be many winners in the streaming space. That's why when you look at a name like Roku, Roku is a name that benefits from all of streaming growth, ad-supported and subscription.

Because it's a TV operating system, it has that platform effect. It's the same as Amazon Fire TV. Those are the two leaders in this space, and those grow as the entire market grows. So when you look ad-supported video on demand, very much in the early innings, and subscription video on demand, very much in the early innings. That's why this story is so strong.

ZACK GUZMAN: Yeah, and Tuna, I mean, when we think about catalysts here, I guess it'd be important to kind of stress that Netflix has been dead money since the summer of last year with that stock kind of trading sideways. And I know so many people are going to focus in on the subscriber number, but we just want to return to the point you made there on the free cash flow side, since that had been an issue for Netflix in catching a respite with the way that production slowed down in this pandemic. So I assume that that would be something people might be watching quickly to see if that was just, you know, a blip in the way that this has been evolving for Netflix. But what would you focus in on in terms of the cost side that all these streamers are facing when you think about bringing new content onto the platform as competition increases?

TUNA AMOBI: Well, obviously, the main cost item to keep an eye on is content. And Netflix should ramp up that significantly this year. Last year, as soon as production resumed, they were almost north of well over 150 originals that have been ramped up since production restarted. So I think for them, the content pipeline continues to be extremely important when you have guys like Disney+ breathing down your neck.

I think investors have come to understand that to be able to compete in this space, your content really has to be top notch. What investors can also take comfort in the fact that Netflix has been batting exceptionally well in terms of their investment in content, originals, as well as acquired content. If you look at some of the recent data we've been getting from Nielsen in terms of the highest watched streaming shows and Netflix has been extremely dominant in that regard.

Both on the originals where they're dominating and also the acquired content. Granted, they're losing "The Office," which is far and away the highest watched shows on Netflix. But they have come back really strong with a lot of other shows to fill that void. But I think they've really demonstrated the expertise in terms of blending the right amount of film, which is an area where you're going to see a lot more ramp up as we kind of look out this year.

But if I can come back, Zack, on the other point that you made about the other question about advertising supported versus subscription. Our recent study actually shows that advertising is going to become more and more the dominant platform. Although, we've seen a lot of platforms going to the hybrid model. Look at Pluto TV, for example, which has really come alive very strongly, and you mentioned Roku, and virtually all the players out there, Peacock, are really kind of deep in that towards into this kind of hybrid model, realizing that to be perfectly competitive, you're going to have to be flexible in terms of offering consumers what size-- what they want. And that's really very important in terms of the competitive landscape that we see evolving.

AKIKO FUJITA: So, Tuna, very quickly. You've sort of laid out the landscape here for streaming. We're looking at Netflix right now at 507 roughly. How much more upside medium-term, and then, Nick, flip the question to you?

TUNA AMOBI: Probably 12-month target of 600. A lot is going to depend on really how this quarter unfolds. It's going to set the tone. As Zack alluded to, we expect that it could be remaining in kind of a holding pattern until much more visibility emerges in terms of how the valuation.

But I think if you kind of look out three years, Akiko, compared to Disney, even on a PE basis, there's going to be some convergence in valuation between Netflix and some of the more established incumbents out there. So net net, we think that's something of a potential risk factor, but something that we would actually continue to monitor the potential downside risk.

ZACK GUZMAN: And Nick, real quick, last word to you.

NICK GROUS: And then, for us, we're long-term investors. So our focus on Netflix is we believe that their subscriber growth, or their subscriber numbers, are going to more than double in the next five years. And then what we're really watching is their pricing power. Netflix currently monetizes at around $0.21. You compare that to where cable monetizes at roughly $0.80. There's tremendous upside in what Netflix can continue to charge their subscriber base.

ZACK GUZMAN: And we'll see what those results out after the bell. Tuna Amobi, CFRA Analyst alongside Nick Grous here at ARK Invest analyst. Appreciate you both joining us. Be well. We'll see what happens.