Most readers likely have a strong opinion about the direction Netflix (NFLX 1.21%), one of the most well-known consumer-facing internet businesses, is heading. The global entertainment heavyweight is at an interesting stage of evolution, going through changes that could benefit it over the long term or slowly diminish its dominance.
Let's consider both the bull and bear cases for this streaming leader looking at 2023 and beyond.
The bulls are pressing play
After Netflix shed 1.2 million subscribers in the first six months of 2022, naysayers thought the company's days of rapid expansion were history. But Netflix proved this wasn't the case, adding 7.7 million customers in the fourth quarter, meaningfully exceeding management's internal forecasts. Even the mature UCAN (U.S. and Canada) region gained users, highlighting that there is still demand for excellent content here at home.
Netflix's lower-cost ad-based subscription is showing promise. For one thing, these users are just as engaged as ad-free members. What's more, management isn't seeing too many existing customers switching down from ad-free plans. That's a good omen for the ad tier's incremental revenue potential.
This is a new phase of the company's life, one in which we can expect it to generate consistent positive free cash flow (FCF). Netflix produced $1.6 billion of FCF in 2022, with leadership predicting $3 billion for the current year. Investors have long waited for this moment, wondering if the business would ever be able to reach a scale that allowed it to stop bleeding cash. The time has finally come.
And this could potentially lead to the company repurchasing shares in 2023. After it spent so much time investing in the core business and keeping adequate cash on hand, investors shouldn't be surprised with the return of capital. This is clearly not the Netflix we've become used to over the past decade.
Another key bull case for the company deals with its current valuation. As of this writing, shares are trading at a price-to-earnings (P/E) multiple of 36, about as cheap as Netflix has sold for during the past 10 years. And according to Wall Street consensus estimates, the business is projected to increase its earnings per share at a compound annual rate of 19.7% between 2022 and 2027, meaning investors could get a lot of growth for what might seem like a high relative valuation.
The bears are pressing pause
Despite Netflix posting strong membership additions, bears will quickly point to sales slowing down. In the fourth quarter of 2022, revenue of $7.9 billion was up only 1.9% year over year (10% on a constant-currency basis). Compared to the company's average annual growth rate of 27.4% between 2016 and 2021, this is certainly a sharp deceleration.
Average revenue per membership (ARM) only rose 5% on a constant-currency basis, which begs the question of how much, if any, pricing power Netflix still has, especially in the U.S. Also, as more users come from international markets, where plans are cheaper, revenue and ARM gains will be under continued pressure.
Competition is fierce in the streaming landscape: Viewers have almost unlimited choices at their fingertips. There is only a finite number of hours in the day, and formidable rival services have the budgets and the intellectual property to command viewer attention.
Because content is an abundant commodity nowadays, Netflix will have to keep investing tens of billions of dollars every year, with no end in sight, to attract new subscribers and keep existing ones from leaving. The company can't just bank on the fact that it provides a better user experience than cable TV, as it did for most of the 2010s. Customer acquisition will become more expensive.
Another reason to believe that Netflix has entered a new phase is the departure of co-founder Reed Hastings from his co-CEO role. Hastings, who has been in the chief executive seat since 1998, will now become executive chairman, no longer handling day-to-day operations.
The tech visionary who correctly bet on the burgeoning growth of internet-enabled video entertainment has managed Netflix through its various strategic pivots over the years. As the business launches into the world of digital advertising and continues to invest in gaming, investors might worry a bit more now that Hastings isn't there to steer the ship.
