After an initial dive in March, the Netflix share price has been on a tear, dipping briefly below $300, before rising rapidly as it became quickly apparent that in the wake of lockdowns in Europe and the US, internet use was starting to rise sharply.

Reports out of Europe that Netflix and YouTube were reducing streaming quality due to a surge in internet use were the first indications that the lockdowns were having the unintended side effect of potentially breaking the internet. These reports also helped prompt investors to re-evaluate expectations around streaming company earnings, which had markets attempting to project how much Netflix, as well as their sector peers would beat their projections for Q1 subscriber growth.

New subscribers boost Netflix share price

In Netflix’s case, subscriber growth blew through market estimates, with the company adding 15.8m new subscribers, well above the 7m estimate. The Netflix share price reacted accordingly to the positive Q1 numbers. As lockdown measures began to ease, the biggest concern for Q2 was whether Netflix would be able to add to these numbers, or whether we would see a Q2 drop-off on account of a pull-forward effect.

Netflix share price slips despite strong Q2 results

In Q1 revenues came in at a record $5.77bn, while market reaction to last night’s Q2 numbers would appear to suggest that the big run higher may well have run its course. This is despite the fact that the company added over 10m new subscribers to its consumer base, well above expectations of 7m.  

The company also saw revenues rise to $6.15bn, again beating expectations, as new users feasted on a raft of new content including Michael Jordan’s documentary, 'The Last Dance'. However, profits still came in short of the expectations of $1.81c a share, at $1.59c, largely due to a one-off charge.  

Despite the better-than-expected revenue and subscriber numbers, caution over Q3 appears to have caused the Netflix share price to slip sharply in post-market trading. The company warned that new subscribers in the upcoming quarter may well come up short, due to pull-forward effects starting to wane as lockdown measures continue to ease further, as we head towards the end of the year.

Management estimates for new subscribers in Q3 were set very low at 2.5m new subscribers, well below expectations of 5.3m, while revenue estimates were set at $6.33bn, also below analyst estimates. These cautious management estimates were reflected in the Netflix share price following the release of the latest reuslts.

Netflix went on to say that it doesn’t expect the current production shutdown to impact its 2020 content slate in a significant fashion. However, some new content may well get pushed back towards the end of 2021.

On an even more positive note the company was cash flow positive for Q2, and said it was optimistic that free cash flow would break even by year-end, as it continues to narrow the gap between what it spends, and what it has coming through the door in revenue.  

To sum up, last night’s negative reaction to the guidance - and subsequent slip in the Netflix share price - may be more to do with much of the good news being already priced in, as well as some investors setting their expectations a little too high.

There is certainly a case for arguing that Netflix isn’t worth the high valuation assigned to it by the markets, however one can’t argue the fact that it is number one in its field by some distance, and continues to set the bar, as far as its peers are concerned.

Stellar year for Netflix so far

Netflix has still had a stellar year so far in terms of new subscribers, so it’s completely understandable for management to reset expectations a touch, given that in the space of two quarters, the company has added nearly as many subscribers as they did in 2019, when they added 27.83m new customers.

Management appears to be being prudent in resetting market expectations, given recent gains in the Netflix share price. They also announced that chief content officer, Ted Sarandos, was being elevated to co-CEO alongside Reed Hastings. Whether that is a wise move or not depends on your view about the wisdom of having two CEOs.   

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