• The   movie, television-series and documentary streaming giant, Netflix, reported   fiscal second quarter results which missed profit estimates but beat revenue   forecasts. The company also confirmed speculation of its foray into gaming as   it hopes to capitalize on its vast library of intellectual property.

  • Revenue rose 19% year over year to $7.3 billion, with revenue growth   this past quarter coming from an 11% increase in average paid streaming   memberships and 8% growth in average revenue per membership (ARM). ARM rose   4%, excluding a positive foreign exchange impact of $277 million.

  • Global paid net subscriber additions came in at a   higher-than-expected 1.54 million, however it lost 400k customers in the   United States and Canada. The Asia-Pacific region represented about   two-thirds of global paid net adds in the quarter, with the company finishing   the quarter with over 209 million paid memberships. Expectations for   subscriber adds was low given that COVID-19 had created lumpiness in   membership growth. Netflix experienced higher growth in 2020 due to lockdowns   and slower growth this year as vaccines were rolled-out and economies opened   up. Netflix said it anticipates 3.5 million net adds for its third quarter,   while investors were anticipating 5.46 million.

  • The company is facing tough year-over-year comparisons. Last year,   in the midst of the pandemic, consumers spent much more time online and in   need of entertainment. This was evident in second quarter engagement levels   being down compared to last year, however, this number was still up 17%   compared with the second quarter of 2019. Additionally, user retention   continued to be strong and was better than pre-pandemic levels.

  • Operating income rose 36% year over year to $1.8 billion, and operating margins expanded to 25.2%. Both revenue and operating margins have increased consistently over time, with Netflix reinvesting the proceeds into the business. This has seen operating profit rise dramatically from around $100 million per quarter in 2016 to nearly $2 billion per quarter so far in 2021. Earnings per share (EPS) for Q2 was up 87% to $2.97.

  • Netflix   has spent $8 billion in cash on content in the first half of this year, as   much as what some competitors plan to spend over the entire year, making it   very difficult to compete with. The company will expand its content offering   to include podcasts which it hopes will reduce churn and capture new users.   This is a positive development and may support adverts to diversify the   company’s one-dimensional subscription revenue stream. Netflix has famously   avoided ads in its video streaming business. Over the past decade, podcasts   have seen a steady rise in popularity. According to Edison Research, 78% of   Americans are now familiar with the term “podcasting” and more than 5 in 10   have listened to a podcast themselves.

  • As a   result, free cash flow (FCF) is fairly constrained, coming in at -$175   million vs. $899 million in the same period a year ago. FCF last year   benefited from COVID-related production shutdowns. However the company   expects full year 2021 free cash flow to be break-even.

  • Whilst   Netflix is an innovator, moving into the gaming arena is a concern to   investors. Only Sony, Microsoft, Google and Amazon have made any progress in   streaming games. Sony had to make two acquisitions and spent billions doing   so - and the other three players are the world’s largest cloud-based services   companies with gaming experience. In terms of more sophisticated gaming,   Netflix faces major technological hurdles. The majority of video games are   only available on dedicated consoles (like a playstation or xbox) or on   personal computers (PC’s). So, Netflix would have to develop a way to stream   games seamlessly online. And if they do that, they will also have to figure   out how to provide users with a game controller that will work across   multiple different platforms - which competitors would want to prevent. Also,   historically, successful video-games based on television shows have been   extremely limited. Iconic film franchises have made some successful video   games like Harry Potter, Star Wars and Lord of the Rings, but again, this   list is also very limited. Does Netflix have enough blockbuster hits to do   this?

  • Initially,   Netflix said it would focus on mobile games, and that they would come at no   additional cost. In terms of mobile games, over 40,000 new mobile games are   produced each year. Few of the 3.5 billion mobile gamers worldwide are likely   to buy a Netflix subscription for the 2-3 potential games they release   annually. The strategy is that it will help fans immerse themselves in the   universe of the shows they love, whilst new seasons (or movies in a   franchise) are under development. But game production comes at a significant   cost. And the hiring spree they’ve embarked upon to bolster this division,   poaching from Apple, Facebook and Electronic Arts, includes resumes with spotty   track records when it comes to actual game releases.

  • Netflix is a great business, and reinvesting to grow and expand has served them and their shareholders well thus far. I am however concerned they are moving too far from their core competency, which is video design and development. But maybe the business has grown to a stage where it needs to stretch its legs. To build podcasts, video games, merchandise and theme parks like Disney and the other entertainment giants holding major IP. Competition has also seen their business model come under pressure in recent quarters. However, with their larger content budget and pipeline it will be difficult to supplant them as the leading streaming service - at least for the time being.