The Less Bad News About Netflix

Motley Fool senior analyst Tim Beyers discusses:

• The market’s relief that second-quarter results for Netflix (NFLX -2.12%) were “less bad.”
• Why Microsoft shareholders have a stake in Netflix’s success.
• Twitter won the first round in its legal battle with Elon Musk.

The Fool’s Ricky Mulvey and Catie Peiper discuss how entertainment companies have dealt with rough economic situations in the past (and how they could respond in the current environment), and preview this year’s San Diego Comic-Con!

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on July 20, 2022.

Chris Hill: Netflix beats expectations and Twitter beats Elon Musk in the first round, anyway. Motley Fool Money starts now. I’m Chris Hill. Joining me from Colorado, Motley Fool Senior Analyst, and he’s fully caffeinated. It’s Tim Beyers. Good to see you.

Tim Beyers: Thank you, sir. You are correct, I am fully caffeinated, and ready to go.

Chris Hill: Let’s start with Netflix then. Shares are up a little bit this morning after the company only lost 970,000 subscribers in the second quarter, not the 2 million subscribers it had originally warned it would lose. I keep hearing this phrase. I heard it after the bell yesterday. I heard it a bunch this morning, and the phrase is “less bad.” That’s the phrase being applied to this quarter. It’s less bad, which is fine. It’s always nice to beat expectations. But just because it’s less bad, I don’t think it means it’s good. You tell me how good were the results from Netflix?

Tim Beyers: I mean, it’s almost like a Miller Light commercial: greg taste, less filling. That’s where we’re at now. Yeah, less bad is the new good, Chris. Here’s what I think. I don’t think this was less bad. I think this was, I mean technically, it’s less bad. The number of subscribers that Netflix was estimated to lose two million is much less than that they came in at 970,000, a little less than a million. That is great and there is reasonable growth, there’s room for optimism here when you strip out the foreign exchange effects, overall growth up about 13%, about 8% to 9% once you factor those in. A pretty good story here. But what we’re looking at longer term is what Netflix is doing to prepare for the future. I think that’s where the optimism lies. Honestly, I think that optimism is fairly well placed. There is some decent work that Netflix is doing to get better at building a long-term growth story. I do like that a lot. They are stripping out about $150 million of regular costs. We should see some improved operating margins on that score. They think that operating margins over the long term, at least for the next couple of years, will hit in that 19-20% range. That’s good. They are still generating cash if you consider the stock-based compensation. But overall, Chris, I like where the company is headed, and I like that they’re leaning into what they have to do. They’re not shying away from this being a challenging time. I’d be way more concerned if they were telling a story that felt unbelievable. Instead, they said, “Yeah, hands up, this is a challenging time.” Here’s what we’re doing about it.

Chris Hill: You have to assume that Microsoft is highly invested in.

Tim Beyers: Hundred percent.

Chris Hill: The ad platform, working for Netflix. Because let’s face it. Satya Nadella and his team want this to work. They want this advertising and they want to grow that business. The single best way to do that is to make sure that Netflix absolutely hits it out of the park with the ad-supported tier when it launches later this year. I’m not a Netflix shareholder, I’m a Microsoft shareholder, so I’m rooting very hard for the Netflix ad platform to work.

Tim Beyers: I think you have good reason to be at least partially optimistic. I mean, we got some news recently that what seems to be driving the Disney streaming efforts is Hulu. The reason is because Hulu has cracked the nut on delivering programming that people want and throwing some advertisements in there and getting some good value out of doing so, they’re driving some real money there. If you think about that as a template for what Netflix can do, I think you can be optimistic here. Now, the way they were talking about this on the call is that they have made real efforts to partner up with Microsoft. They talked about technology. They talked about the ad serving platform. They talked about the tools that Microsoft has and that this is a fairly deep partnership. They selected Microsoft on the merits. But Chris, I think we can both go beyond that and say that Microsoft, in and of itself as an ad business, is doing billions upon billions of dollars. I think it’s $10 billion actually in terms of their ad business right now. There is a lot of there there. But in addition to that, Microsoft has a lot of experience in figuring out hard problems, and they have a lot of tenured people that they can throw at this problem. They have big incentives to get good in this area because their main rival, Google, is already really good in this area. They would like to have this work and be able to take that experience and put it in other places. There is no word that this is in any way an exclusive deal for either Microsoft or Netflix. I like that a lot. I agree with you. I think there’s a lot to root for and I think there are some things to be optimistic about, both on the Netflix and Microsoft side of things.

Chris Hill: In the case of Twitter v. Elon Musk, round 1, went to Twitter. Attorneys from us were hoping to delay the trial until next year, but the judge ordered an expedited five-day trial to begin this October, so get the popcorn ready. Anyway, you’d like to handicap this. I know you’re not an oddsmaker, but based on what you’ve seen so far, what stands out to you?

Tim Beyers: Well, I think the main thing that stands out to me is that Elon Musk is not getting what he wants and he’s going to have to make a decision that I think he doesn’t want to make sooner than he wants to make it. I imagine there are legal discussions happening right now somewhere in a conference room, either at Tesla headquarters or SpaceX headquarters or somewhere. But I think Elon is talking with lawyers because his options now are growing more limited by the day. Which is interesting if you’re looking at Twitter. Because right now, Twitter is valued. I think as we’re recording Chris, it might be around $40 a share, maybe slightly less than that. Maybe this isn’t worth $54.20 a share. Maybe not. But do you think that the odds are, given what Elon is going to have to face, that it’s worth more than $40? I think the answer to that is, “Yeah, probably so.” Elon Musk has some decisions to make. I know that any of those decisions are comfortable, whether that is buying Twitter outright or leaning into some settlement. I think both of those are on the table, and there’s a real high probability that one of those two things happens. If I had to handicap it, Bill Mann said this morning on the Morning Show that it’s 85%. I don’t know that I’d go that high, but I think it’s at least 75%. Yeah, not a good time — it’s hard to say that right. Usually, Elon Musk is on top of the world. I don’t think that’s true anymore. I think it’s not a great day to be Elon Musk.

Chris Hill: It’s a great day to be a reporter covering this because whatever is the outcome here, I have to believe there is an award-winning book underneath, behind the scenes, tell-all of really just this entire calendar year starting earlier in the spring when he came out and was like, yes, I’m buying it.

Tim Beyers: Chris, you’re not thinking big enough. You’re not thinking big enough. Not only is it a book, but it’s also a documentary, and it’s an HBO mini-series that is 100% happening. Come on, you know, that’s happening, right?

Chris Hill: Yeah, it probably is particularly when you think about the Uber mini-series that came out earlier this year.

Tim Beyers: Hundred percent.

Chris Hill: The one about Theranos. Look, just start the casting now for Elon Musk.

Tim Beyers: Yeah. That’s right, and he will have a hand in that. But you are right. I mean, this is going to change the way that people look at him, will change the way people look at his deal-making. This may be the first time, really that Elon Musk actually gets his hand caught in the cookie jar and doesn’t actually pull out a cookie. That would be really interesting. It changes the dynamics a little bit because, up to this point, he really has been as close to untouchable in business as any executive has been, at least in recent memory, Chris.

Chris Hill: Tim Beyers, always great talking to you. Thanks for being here.

Tim Beyers: Thanks, Chris.

Chris Hill: The smaller than expected loss of subscribers may have been a relief for Netflix shareholders, but the streamer still has a lot to prove. Ricky Mulvey and Catie Peiper take a look and how entertainment companies have pivoted in past recessions, and how they could respond in the current environment.

Ricky Mulvey: Well, we might be in a recession, which means budgets are getting cut, but that doesn’t necessarily mean that the entertainment spending is going down, so what does the history tells us and what’s this say about entertainment companies? Joining us now is Catie Peiper. Before working at The Motley Fool, she got her PhD in media studies from the University of Southern California. Welcome Catie.

Catie Peiper: Thank you.

Ricky Mulvey: We’ve talked about the lipstick effect on the show before. Maria Gallagher and Chris had a great conversation about it, but it’s this idea that people still spend on small indulgences even when there’s an economic downturn, recession, depression, you name it. So what is this effect mean for entertainment spending, and how have we seen it play out historically?

Catie Peiper: Yeah, this is a really interesting question because one of the oldest stories or myths that is told around Hollywood or in screen crafting classes across the world is that the Great Depression was the best thing that could have ever happened for the entertainment and film industry. They were just getting their legs at the time, and the story goes that people were so frustrated with the world, so despairing of the economy and had so little faith in the economy that they just wanted to spend their money at the movies and escape for a little while. It makes a great story, but it’s not true. At least not entirely. I’m sure some people were as YOLO as I would be today when I spent $20 on a movie ticket, but it’s not quite the same thing as a $5 or $7 tube of lipstick. It really happened back in the Great Depression is there were so many studios, as many as you can count on hand and toes, and they had to consolidate. They had gotten into a lot of debt for 1920’s dollars it was over $400 million in debt across all of the studios. It’s a lot of money back then. They had to start consolidating. They had to start figuring out how to scale movie production profitably. This is how the studio system where stars became part of their stable house was invented, was basically to increase that profitability. It’s not that the depression was good for movies in that people didn’t care and spent their money, it was good because it forced the companies, the entertainment studios, to be better about how they spent their money.

Ricky Mulvey: That was also at a time when if you wanted to be entertained, that was one of your only options. You didn’t have a television.

Catie Peiper: Yes.

Ricky Mulvey: Radio was still on its nascency.

Catie Peiper: Yes.

Ricky Mulvey: That was a great podcast called Plain English with Derek Thompson and he pointed out in a recent episode that essentially movie tickets bought per American peaked in about the 1930s, 1940s. I know that’s a little bit past the depression, but that was 35 movie tickets per person in America at the time. The declining ever since now it’s about two or three. I’m not saying the depression had a lot of macro tailwinds, but if you’re an entertainment company, you benefit from being the only game in town at that point.

Catie Peiper: Absolutely. I would say it’s not just being the only entertainment company in town, it’s the only pastime company in towns in many ways. If you go listen or you read oral histories of people who are living and were the consumers during that period, they talk about going to the movies as if the way we would talk about going to spend time in the mall in the ’90s. It was a place that was cooler than it was hot outside. You got your news, you got entertainment. It was a social event. It wasn’t just that you were going to go see the newest Avengers film.

Ricky Mulvey: We’re going to skip forward to the Great Recession [laughs] because I do think there’s some lessons from that time period in particular as we look to see how entertainment companies will pivot moving forward. 2008 was basically when Netflix pivoted to streaming. That’s when they really leaned into it. What are some of the lessons as you think back to the Great Recession for entertainment companies to pull out moving forward is as we look toward this one?

Catie Peiper: Yeah, that’s a really good question. What’s interesting during the great recession, as we saw similar behavior as during the Great Depression where these entertainment studios had to tighten their belts as they had to get more efficient with their spending. They started looking at other ways to account for their revenue. Rental films had been a part of their equations since the late ’90s, but now they had to start thinking about streaming revenue and long-term IP. I’ve said this the last time I was on the show, but really the services that have the most ROI per asset. If you think about HBO, excuse me, they have a more limited catalogue than Netflix did at the time, but they’re getting a higher return on that asset in terms of views and subscribers. Those are the ones who were best setup during the great recession and probably the ones who are also going to be the best setup now.

Ricky Mulvey: Let’s skip ahead to HBO. Particularly it’s now rival with Amazon because instead of just having studios, essentially studio rivalries, you now have these streamer rivalries. I think the biggest one is playing out between HBO and Amazon regarding essentially the future of the fantasy landscape. You have Amazon coming out with this Lord of The Rings spin off, The Rings of Power, and then you also have HBO’s House of the Dragon coming out within just a few weeks of each other. What are you looking at, how are you seeing that play out?

Catie Peiper: It’s interesting. What I would say is it’s half deliberate and half coincidental, and this is something that you see very frequently in the film industry. Our HBO and Amazon going head-to-head for the same mindshare in the consumer consciousness absolutely. They want to be the biggest person in the ring. But did they set out to be the top fantasy business? I would be a little bit more skeptical of that. What I think is really interesting about both of those is they’re spinoffs, and that’s the big keywords. They’re both looking to double-down on sure things that have performed in the past, which is always a behavior that we see during market insecurity in the entertainment industry is that they look toward investments that are predicated on other successes in the past. They’re trying to use that data to inform what they do. The other thing is they’re looking at the same consumer data. If fantasy topics or IP are trending in their catalogs, they’re going to start putting more money behind developing that. It makes sense that they’re getting the same data on both platforms. It’s a little bit of a coincidence that they’re both fantasy, but it’s not a coincidence that they’re both doubling down on previous successes.

Ricky Mulvey: I’m not doubting that having a back catalogue of intellectual property is an advantage, particularly for someone like Disney and Disney+, you can plop your child in front of a Disney Plus screen and then probably go away for a few hours. You’re seeing similar things with Paramount+ HBO obviously leaning on Game of Thrones. I wonder if there is an advantage for Netflix in not having that, in that they have to be scrappy. That has allowed them to, I guess, essentially create the new wave of reality television shows with things like Love is Blind. I don’t think you have the squid game phenomenon if you’re able to lean on a bad catalog like Disney can with the Star Wars franchise.

Catie Peiper: I would agree with that. I would say that Netflix is superpower, always figuring out how to do what the other mainstream providers, whether it’s Disney or HBO, have more money to do. With Netflix, it’s often acquiring international content like Squid Game. They do have that scrappiness, but if you look at the spread of their money versus the number of IP they’re acquiring, there’s just a lot of bloat there. That’s the downside of it is that they can’t be certain that they’re betting on a sure thing when they acquire that information or that IP. The other thing is, I think there are a lot of signals if you pay attention to industry news showing that Netflix is pretty nervous themselves at the moment. They recently updated their culture memo internally for their employees. Previously their culture memo had a section saying that we’re not going to reduce your salaries during difficult times because we want to reward good business savvy. They took that out, which is a pretty interesting statement by omission.

Ricky Mulvey: Yeah, Netflix is on the ropes certainly, and I think it’ll be interesting to see how they come out of that. As a Netflix shareholder, I’m trying to be bullish on the company. This weekend we have Comic-Con going on for the first time in a few years. What are you watching for as Comic-Con happens in San Diego?

Catie Peiper: Great question. I have to say as someone who has been at Comic-Con past, who has watched Comic-Con for years, I am very jaded by how much money goes into the publicity stunts by the big studios at this point. I tend to not pay as much attention to the noise. It’s just being generated by the studios. Really, it’s just a signal of how much money they’re willing to sink into a franchise. But it doesn’t actually mean that there’s going to be revenue that follows. What I usually watch for, and what has held true this year so far is where the fans are going. I don’t just mean who’s talking about on Twitter, although that can be an interesting sentiment. I’m looking at things like, suddenly we have a show that it is named, Our Flag Means Death. It’s from HBO, and it suddenly has more cosplayers showing up to conventions across the country similar to Star Wars or Marvel. This tiny little show in its first season is already getting a strong presence. Its fans are driving sellout merchandise in the market at Target and other retailers. Not because it’s licensed merchandise for the show, but because the fans saw something that they thought tied into the show. These are big market-moving forces similar to what we see with like K-pop fans. But it’s from a show that has relatively gotten little publicity in other respects. It had been at the top of the chart for most anticipated or most in-demand show on streaming services for five weeks straight, even eclipsing Disney’s Moon Knight. I tend to look more at where’s the fans sentiment and where’s the fans demand coming from and less where the publicity budgets are.

Ricky Mulvey: It was hard to be excited about Moon Knight. But hey, we’re not listening to the tweets, we are watching what the cosplayers are doing. I love that going into this weekend. Catie Peiper from The Motley Fool. Thanks for joining us.

Catie Peiper: Thank you.

Chris Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against them, so don’t buy yourselves stocks based solely on what you hear. I’m Chris Hill, thanks for listening. We’ll see you tomorrow.