Most of Netflix’s fourth quarter revenue growth comes from 2 sources – and 1 is not sustainable



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By most accounts it was an exceptional fourth quarter for Netflix (NASDAQ: NFLX). The streaming leader brought in 8.5 million additional paying customers, easily exceeding Wall Street estimates. It has also more than doubled its operating profit year on year, underscoring the triumph of membership growth.

Beware, however, that Netflix’s fourth quarter profit margin explosion is the new normal. The streaming giant has cut spending in an area where it can’t afford to skimp for long. In fact, we are already seeing subtle evidence of the negative impact of this cost reduction.

Woman using a calculator at a desk.

Image source: Getty Images.

Curious cost reduction

Last quarter revenue of $ 6.64 billion was a 21.5% year-over-year improvement. The cost of Netflix’s revenue – its spending on acquiring or producing video content – has also increased, but not as much. The company spent $ 4.16 billion on content, up 20.2% from the $ 3.46 billion it spent in the last quarter of 2019. Technology spending increased by nearly 9% year on year, while administrative expenses increased by 8.2%. Keep in mind that administrative expenses are the smallest part of this business’s operating costs, so its slower growth has produced the least tax benefit.

There is, however, a curious disparity in Netflix’s fourth quarter tax returns. Rather than increasing at the same rate as other expenses, marketing expenses fell 13.2% year over year, from $ 878.9 million to $ 762.5 million. This difference of $ 116.4 million represents about a quarter of the additional $ 496 million the organization reported as operating income in the fourth quarter. And, assuming that marketing spend would have otherwise grown in the same way as other spending in a non-pandemic environment, one could argue that the decline in marketing spend led to almost half of the profit growth of Netflix.

Metric Q4 2019 Q4 2020 Change % Change
Returned $ 5.467 billion $ 6.644 billion $ 1.177 billion 21.5%
Cost of income $ 3.466 billion $ 4.165 billion $ 699 million 20.2%
Marketing $ 879 million $ 763 million ($ 116 million) (13.2%)
Technology and development $ 409 million $ 487 million $ 78 million 18.9%
general and administrative $ 255 million $ 276 million $ 21 million 8.2%
Operating income $ 458 million $ 954 million $ 496 million 108.1%

Data source: Netflix.

Maybe it doesn’t matter. As it has been noted, Netflix recorded another 8.5 million subscribers in the last quarter, bringing its full-year gain to 36.6 million. The company is also already a market leader and could simply face saturation headwinds.

However, Netflix appears to have paid a price for not promoting its product as aggressively as it once has, and despite the marked increase in promotional spending from moderate levels in Q2 and Q3.

Cause and effect

Market research firm Kantar explained earlier this month AT&THBO Max was the big fourth quarter winner in terms of new streaming media listings in the United States. In total, HBO Max won 19.2% of total national subscription video-on-demand registrations. The second best platform was Amazon‘s Prime, with 18.2% new SVOD subscribers. Walt disneyHulu and Disney + came in third and fourth, respectively, with 13.7% and 13%. Netflix’s fifth place was a disappointing 7.4%. In this vein, only 860,000 of the 8.5 million members registered by Netflix in the fourth quarter live in the United States or Canada.

There is nothing fundamentally wrong with it. Netflix’s streaming service has been available in the United States for over a decade, and there is a real possibility that it is close to market saturation here. This is why its international activities have been a high priority for some time now.

Yet Netflix only has 73.9 million subscriptions in Canada and the United States, compared to 135 million households in both countries. It is 61 million potential households that Netflix could still integrate.

Here’s another way to look at it: How come Netflix’s membership growth was so much lower than its competitors’ subscriber growth in the fourth quarter. despite Netflix is ​​great sequential increased marketing expenses?

Netflix has spent significantly less on marketing lately and may be paying the price.

Data source: Netflix. Chart by author. Dollar figures are in thousands.

Investors should consider whether these results relate to promotional spending cuts that began in 2019. If slowing growth in North America is a harbinger of similar issues looming on the international front, perhaps be that cutting marketing spending right now is not the ideal solution.

Worth watching

Netflix is ​​not doomed. The king of streaming is still profitable and is increasing its margins other than through its unsustainable spending cuts. Revenue increased nearly $ 1.2 billion year-over-year in the fourth quarter, for example, while its cost of revenues only increased by $ 700 million. The company’s fourth quarter letter to shareholders even noted its progress towards sustained positive free cash flow, adding “we believe we no longer need to raise external funding for our day-to-day operations.” This means that the company should soon be able to add revenue without spending as much or more on programming.

We cannot assume that the share of Netflix’s margin growth rooted in declining marketing spend is sustainable. Many people still largely self-quarantine and are looking for ways to alleviate their boredom. But, with the coronavirus vaccines currently being distributed, it will become more difficult to get their attention. The advent of HBO Max in a competitive market that already includes Disney + means that Netflix may have to spend even more on marketing – not less – than in the past.

This is definitely something current and potential Netflix shareholders need to watch out for.



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