Editor's note: This article has been corrected. Netflix reported 220.67 million global streaming paid memberships in the second quarter, a drop of about 970,000 from the previous quarter.
Less than a year ago, Netflix (NFLX -0.44%) stock was trading at all-time highs. But as technology stocks have entered a mode of valuation reset fueled by consumer concerns over inflation, the streaming pioneer's stock has flipped upside down. With shares cratering nearly 60% year to date, executives at Netflix have begun to explore new avenues for growth -- namely additional revenue drivers in the form of advertising and strategic alliances.
However, there are arguments to be made that Netflix is an attractive buy at its current valuation. Let's explore how Netflix might attempt to recapture its audience, and whether the stock looks like a good long-term buy.
How does the current picture look?
On a year-to-date basis, Netflix's results have been mixed. In its first-quarter 2022 earnings release, investors learned that the company lost around 200,000 subscribers. While this appears alarming on the surface, management explained that the company suspended its services in Russia due to the ongoing war with Ukraine. If investors normalized subscriber metrics to account for this decision, then paid memberships actually would have increased by 500,000.
Unfortunately, investor sentiment began to dwindle following the company's first-quarter earnings. At the end of Q1, Netflix's guidance for Q2 memberships was 219.6 million. The company recently reported Q2 results and while it beat that subscriber estimate the number of subscribers was down 1 million from the Q1 number.
The second quarter was packed with original content, headlined by the latest installment of science-fiction thriller Stranger Things as well as Adam Sandler's latest movie, Hustle. According to company statistics, Stranger Things accounted for 1.3 billion hours viewed in its first month on the platform. To put this into perspective, this is the largest season of English-language TV in Netflix's history. Unsurprisingly, the latest season of the show restored viewership for prior seasons as well.
Is the Netflix Effect real?
One of the most interesting aspects of Netflix's second-quarter shareholder letter was management's commentary on how the company influences pop culture. Using Stranger Things as an example, two songs from the 1980s were featured prominently throughout season four. Following the debut of the latest season, both of these songs rocketed back up the charts in both the U.S. and U.K.
Additionally, the company is beginning to see a lot of success beyond television and limited series. Hustle, starring Adam Sandler, is a comedy-drama feature film about a struggling basketball coach. The movie includes several active and retired professional basketball players, coaches, and media personalities in cameo roles. According to the company's data, Hustle was Netflix's biggest movie in Q2 with 186 million hours viewed.
While 2022 has been rather volatile for the streaming giant, the company has proven its ability to influence audiences across different genres and media formats. Producing top-notch original content once seemed like the company's biggest challenge, yet now Netflix faces something potentially more daunting. Management must figure out a way to acquire new customers while simultaneously retaining existing subscribers, and to do so beyond big-budget television and film.
Over the last several months, Netflix has made great strides in expanding its brand beyond traditional streaming. Just as Walt Disney has theme parks, and relationships with toy manufacturers to sell novelties and collectibles that promote its content, Netflix is now following a similar path.
Netflix recently partnered with company Candy Digital to distribute a collection of Stranger Things-themed non-fungible tokens (NFTs). Should this initiative prove successful, Netflix could have the ability to form a long-term alliance with Candy Digital in an effort to produce crypto tokens and digital collectibles for its most popular series.
What's more, as the company expands more into Web3, the third generation of the internet that gives users more control, it's not surprising that Netflix is also pursuing different gaming formats. Over the last year, Netflix has acquired three gaming studios, and it currently has a portfolio of two dozen mobile games. While Netflix has yet to generate meaningful gains from these investments, it's making a concerted effort to differentiate its products and services to compete with other streaming and media conglomerates; investors should be encouraged.
Another potentially meaningful development is that management has been hinting for quite some time about plans to introduce a low-tier streaming option that includes some form of ads. Perhaps most exciting is that during its Q2 earnings call, the company announced an alliance with Microsoft (NASDAQ: MSFT). Because Microsoft is investing significant capital into TV advertising, Netflix tapped the computer giant as a channel partner to help launch its own advertising service. Management made it clear that this new, ad-inclusive tier will not launch until 2023.
Keep an eye on valuation
While Netflix has a long and arduous road ahead, it's difficult to look past its current valuation. At the end of Q2 2021, Netflix's market capitalization was over $230 billion; the company was trading at a price-to-earnings ratio of over 60, and at a (trailing-12-months) price-to-sales multiple of over 9. As of this writing, Netflix's market capitalization is $100 billion, and the company trades for 20 times earnings and 3 times trailing-12-months sales.
Although Netflix's valuation became overextended due to stock-market euphoria during the pandemic, investors could argue that its current valuation is a buying opportunity. The company must prove to investors that its investments in Web3, gaming, and advertising will lead to higher revenue and profit in the form of net new customer acquisition over the long term. But now may be a chance to dollar-cost average into existing positions, or initiate a new position while prudently assessing future earnings and product development.