Investors were disappointed when Netflix (NFLX 2.00%) reported its fiscal fourth-quarter earnings. Not only did subscriber additions come in below management's own guidance, but its outlook for the first quarter also came in well below analysts' expectations.
But CFO Spence Neumann isn't overly concerned about subscriber growth. At a recent investor conference, he said people have "overly focused attention on subscriber numbers," before adding, "What we focus on is building a great business." Specifically, he called out three key metrics: revenue, profits, and cash flow.
Image source: Netflix.
Growing revenue
Neumann is targeting double-digit revenue growth for the foreseeable future. There are two ways for Netflix to grow its top line: It can add more subscribers and raise prices. Ideally, it can do both at the same time, but it's become clear in recent years that consumers are becoming a bit more price sensitive. That didn't stop it from enacting another price hike in the U.S. earlier this year, which Neumann said weighed on first-quarter subscriber additions.
Steady price increases should sustain Neumann's double-digit revenue outlook, but Netflix isn't raising prices in every market. It lowered prices in India, for example, where market costs are much lower than other regions Netflix operates in.
Neumann says pricing isn't based on competition, but it's worth noting Walt Disney has seen much more success in India with Disney+ Hotstar. Disney's service costs just a fraction of Netflix's, and the company counts nearly 46 million Disney+ Hotstar subscribers. For reference, that's nearly 1.5x more subscribers than Netflix counts in all of its Asia-Pacific region.
Finding the right balance between pricing and subscriber growth is key for Netflix to grow revenue.
Growing profits
Netflix's long-term outlook is to increase its operating profit margin by about three percentage points every year. For fiscal 2022, Neumann expects an operating margin of 19% to 20%, which is actually a decline from the 20.9% operating margin the company produced in 2021. However, the impact of a strengthening dollar versus foreign currencies will have a significant effect (about two percentage points) this year. Adjusting for foreign-exchange rates, Netflix is still on the proper trajectory to expand its operating margin.
To that end, Netflix can effectively manage its margin pretty well by adjusting its content spend with regard to its revenue growth. Restricting its content spend based on a profit-margin goal forces Netflix to make decisions about what content is most likely to drive engagement and subscriber satisfaction. As it gains experience, it becomes better at knowing what content will be the most efficient use of its budget.
That said, there's still room to grow the budget in some categories, Neumann says. Netflix might not need more English-language sitcoms and dramas -- it just needs the best it can buy. But in international markets, or in certain verticals like animated films, it could still up its spending.
Growing free cash flow
Netflix has burned cash for nearly a decade as it ramps up its original productions. But the company has gotten to the point that its cash outlays for new content aren't growing as fast as revenue in the last few years, and it expects 2022 to be the year free cash flow turns positive again.
Generating positive free cash flow is, again, a matter of balancing the content budget with revenue growth. And with a substantial portion of Netflix's budget now going toward original series and films, the growth in cash outlays for content isn't rising as fast as it had in the previous decade. Still, management must be mindful of which projects it green-lights and which it produces in-house, partners for, and licenses. Meanwhile, licensed series can still play a valuable role in Netflix's content library.
The underlying factor
The underlying factor to all of the above is subscriber engagement. Higher engagement rates allow Netflix to justify price increases. Higher engagement means it's managing its content budget more efficiently. And the combination leads to better profits and cash flow.
Unfortunately, the company doesn't provide much in the way of user engagement data. As such, investors will have to pay attention to the above three metrics and listen to management's commentary during investor conferences and earnings calls to learn more about how Netflix is driving engagement.
