Netflix (US:NFLX) and Spotify (US:SPOT) are on similar paths. Both spent big on content during the pandemic to grow quickly, then lost the gains their share prices made as interest rates rose and the market questioned their ability to increase profits. Yet their recent earnings showed resilience by proving they could keep growing their subscriber bases while bringing costs under control.
In the three months to September, Netflix managed to add 9mn subscribers compared with the previous quarter. Its 247mn subscriber figure is up 11 per cent year on year and 3.6 per cent quarter on quarter. Impressively, it achieved this growth despite cutting its marketing budget by 11 per cent year on year and expanding its operating margin by 3.1 percentage points to 22.4 per cent.
At the start of the year, Netflix founder Reed Hastings shifted to executive chair, with existing co-chief executive Ted Sarandos joined by Greg Peters in the shared top role. Since then, the company has been a lot more frugal with its cash. This focus on cash flow was given an unexpected boost by the Hollywood writers’ strike as it forced a lot of production to be put on pause. Content spend dropped to $2.9bn (£2.4bn) this quarter from $3.7bn in the same period last year. The savings from the strikes mean management has been able to boost its full-year free cash flow forecast by 30 per cent to $6.5bn.
Exceptional profitability
Similarly, Spotify has been able to attract more users on a smaller marketing budget. It cut this by 18 per cent while managing to grow its premium subscriber base by 16 per cent to 226mn. This helped the music streamer swing from an operating loss of €228mn (£198mn) to a profit of €32mn. The average revenue per user was well ahead of forecasts, as well, at €4.34. Investment bank Jefferies had pencilled in €4.25 for the third quarter.
Some analysts question whether Spotify can maintain this growth rate while continuing to cut back on expenses, however. “We need to consider the sustainability of the top-line growth, which is partially dependent on emerging market [subscriber] conversion and the new cost structure,” Jefferies analyst Andrew Uerkwitz said. Spotify also benefited from pulling back from huge spending on content. While Netflix and other streamers were throwing billions at new TV shows and films, Spotify handed popular podcasters lucrative, multi-year deals. Joe Rogan was reportedly signed for $200mn for three and a half years in 2022.
It’s not obvious how Spotify managed to both drop marketing spending and increase subsciptions. Chief executive Daniel Ek praised the team culture but gave little other detail on its earnings call last week. “[CFO Paul Fogel] and I kind of set that objective for the teams, what started happening was they started focusing a lot more on the performance marketing mix,” he said. “And we started seeing the top line holding up and even accelerating.”
At Netflix, there was no mention from management of the increased marketing efficiency. However, compared to Disney’s (US:DIS) faltering streaming business, it shows that something is clearly working better. Disney+ subscribers have fallen from 164.2mn in September last year to 146.1mn in June, although it also lowered marketing spend in a bid to stem losses.
Growth set to accelerate
Netflix subscriber growth clearly benefited from its password-sharing clampdown. Management has been careful with the rollout so far, looking at usage data to identify which users are most likely to pay for a second account and targeting them first. Users can even shift a profile across to a new account and hold onto their places on individual shows. This gradual rollout means it will keep benefiting from this tailwind for a few more quarters. “I would say we have incremental acquisitions, incremental adds for the next several quarters,” said Greg Peters.
Netflix's operational improvements mean that even though the price has gone up, its price to free cash flow ratio it is as cheap as it has ever been. Its currently trading on 30 times its forward free cash flow, compared to over 300 times in the midst of the pandemic bull run.
At Spotify, analysts similarly believe the best is still ahead, and expect a revenue acceleration in the fourth quarter as its recent price increases kick in. Currently, FactSet broker consensus is for €3.9bn in revenue for Q4, which would be up 14 per cent year on year. “It’s no longer a question of if Spotify will achieve profitability… it’s how much in EPS can the core business do and where does it deserve to trade,” wrote Uerkwitz.
In terms of cash flow and profitability, these two are winning the streaming wars for now.
