The good news is that Netflix (NFLX 4.17%) added nearly 7.7 million paying customers during the fourth quarter of last year, handily topping expectations. The bad news is that net subscriber growth came at a price.
That's the big takeaway from Netflix's quarterly results. The top line is now quietly contracting as is the bottom line, and the company can't afford for the crimped results to become the norm.
If this sort of spending is the shape of things to come (and it very likely could be), current and would-be shareholders might want to rethink their expectations.
Netflix's operating costs are on the rise
The fourth quarter might have been a one-off in terms of waning revenue and growing costs. But with the streaming market's maturing competition, dismissing last quarter's poor profit margins as a fluke is risky.
For the first time in recent history (and despite the best subscriber growth seen in the past four quarters), Netflix's top line has now slumped for a second quarter in a row. That's because the bulk of its recent customer growth is overseas, where the company's monthly rates are lower.
In the meantime, average revenue per user fell last quarter in all four of its key geographic markets. Also, Netflix's marketing and technology costs along with its cost of revenue (the price of buying or producing its programming) reached their highest relative levels in years. That drove operating-income margins to their weakest level in years.
Data source: Netflix. Chart by author.
To put that into perspective, the chart below shows the fourth-quarter operating expenses and income from the last six years. It shows that Netflix tends to spend heavily on marketing and content near the end of the year; it appears the company makes a big promotional push around the holidays. Nevertheless, even by fourth-quarter standards, the 2022 final quarter was alarmingly expensive, biting into profits.
Data source: Netflix. Chart by author.
It's a red flag simply because Netflix's revenue has more than doubled over the past five years. This sort of scale-up in the company's operating expenses should be driving wider profit margins and lower relative costs. But things are the other way around.
The unsurprising sign of stiffer competition
More competitors are the reason for this trend -- even if Netflix is still the king of streaming. It had 230.7 million subscribers as of the end of last year. The nearest single platform with a confirmed figure of paying customers is Walt Disney's Disney+, with 152.1 million as of July.
Amazon indicated there were over 200 million Prime subscribers in 2021. But that was in the throes of the pandemic, when the world was still doing much of its shopping online.
Also know that Netflix is cash flow positive, and believes it will at least improve last year's cash flow on the order of 50% this year. But that outlook is in question given how Netflix's share of the streaming market is shrinking.
Market researcher Kantar reports that Amazon's Prime, Paramount, Disney's Hulu, Warner Bros. Discovery's HBO Max, and Comcast's Peacock all saw more U.S. customer signups than Netflix has in every quarter between the third quarter of last year and the third quarter of this year.
Netflix's revenue peak and weakening margins are taking shape right as all of these and other streaming services are just reaching their full stride. That can't be a coincidence.
Netflix is hardly doomed. Indeed, the last quarter might simply reflect a highly unusual, circumstantial surge in operating expenses. But the fourth quarter might also be an indication of the spending needed to keep its platform competitive with so many streaming newcomers now finding their sea legs.
If you own Netflix or are considering it, you'll want to see clear progress in the other direction three months from now. It's a tough name to step into in the meantime.
