Streaming giant Netflix (NFLX 2.42%) lost fewer subscribers than expected in the second quarter. The company is working on a variety of initiatives, including an ad-supported tier and the monetization of password sharing, in an effort to shore up both the subscriber count and revenue in the coming years.
One thing Netflix has little control over, though, is the strength of the U.S. dollar. Netflix sells its services in over 190 countries, generating revenue in local currencies but reporting results in dollars. With the value of the dollar surging relative to other currencies this year, Netflix's results are taking a big hit.
A small revenue problem, and a big profit problem
Netflix reported revenue of $7.97 billion in the second quarter, up about 9% year over year. Because Netflix generates the bulk of its revenue from outside the United States, movement in currency exchange rates impacts the company's reported revenue. Netflix's revenue was reduced by $339 million in the second quarter due to these fluctuations.
Let's take the euro as an example. If the exchange rate between the U.S. dollar and the euro were to remain unchanged from one period to another, 1 euro of revenue in each period would translate into the same number of dollars for reporting purposes. But if the value of the euro sinks relative to the dollar, each euro of revenue would translate into fewer dollars in the later period. A year ago, 1 euro translated into around $1.18. Today, 1 euro translates into just $1.02.
The same story is playing out with other currencies, and the net result is a significant revenue headwind for Netflix. In Europe, the Middle East, and Africa, Netflix reported a 4% revenue decline in the second quarter. Excluding currency effects, revenue would have grown by 6%. That's a 10% swing purely due to currency. Netflix expects to report just 5% overall revenue growth in the third quarter as currency reduces growth by 7 percentage points.
While Netflix generates revenue in foreign currencies, most of its expenses are in dollars. If that weren't the case, currency would reduce expenses right along with revenue and minimize the impact to the bottom line. But since Netflix is spending dollars, expenses receive no benefit from a strong U.S. dollar.
Netflix is forecasting a 29% year-over-year decline in operating profit for the third quarter. Almost all that decline is due to currency. At constant currency, operating profit is expected to decline by just 3%. Investors shouldn't be happy about any decline in operating profit, but Netflix's reported result will appear much worse than it really is.
Netflix has more serious issues
While currency is making Netflix's revenue growth and profit look bad, it's really the least of the company's concerns. Netflix is facing down a host of high-quality competitors that have meaningful advantages when it comes to intellectual property. While Netflix has plenty of popular shows, Disney, for example, has a catalog of IP that's unrivaled in the entertainment industry.
As inflation puts pressure on household budgets, and as a potential recession looms, paying for four or five different streaming services at the same time may start to seem excessive to some. Netflix has some big hits, but it may be the easiest service to cancel and periodically rejoin when there's something worthwhile to watch. The company has taken a quantity-over-quality approach to content, which is probably not going to foster much loyalty.
The currency headwind facing Netflix will eventually fade away, but the content and competition problem will be much harder to solve.