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Netflix Beat Masks Bigger Problems
Netflix Beat Masks Bigger Problems

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  • Yahoo

Netflix Beat Masks Bigger Problems

Netflix (NASDAQ:NFLX) outperformed Q1 2025 earnings estimates with a 25% surge in earnings per share and near-record levels of operating margins. But under the hood, its free cash flow paints a different picture. Its new shift into advertising, live programming, and gaming could hold long-term potential, but in the near term, it's driving cost increases, squeezing margins, and uncovering weak points in monetization quality. Netflix reported diluted EPS of $6.61, significantly above the $5.68 expectation, with revenue increasing 13% year over year to $10.54 billion. Operating margin was 31.7%, close to all-time best levels, driven by price hikes and stable additions of free cash flow ($2.66 billion) increased at a more subdued clip. A large part of the beat was facilitated by content amortization timing and delayed spending, not cash-driven profit. This differential between accruals and cash has been a chronic trend at Netflix, headline profits leap, but underlying cash dynamics add to the tension. Revenue growth at UCAN slowed to 9% YoY from 15% in Q4 owing to normalization of plan mix and the lack of NFL-related ad spikes. APAC increased by 23%, and LATAM by 8%, but these markets have a correspondingly lower ARPU that constrains contribution to operating income. Content liabilities stand at $21.8 billion, with amortization spiking. Netflix is pre-paying spend into live sports, global content, and unscripted programming, all genres of high variability and uncertain ROI. The vision is obvious, but so too is the cash burn risk building. Source: Shareholder letter Netflix is no longer a subscription business, it's becoming a vertically integrated entertainment platform. The strategy has three pillars: ads, live programming, and interactive content. The new Netflix Ads Suite arrived in April in the U.S. and Canada, with native programmatic capabilities and more sophisticated targeting. Growth into the rest of the EMEA and LATAM regions is in process, aiming to reach double ad revenue by 2025. That said, advertising still contributes a "very small" percentage to income today. The competition is tough: YouTube has scale, Hulu has access to the Disney ecosystem, and Amazon has commerce bundling. The live programming drive is more mature. Netflix's purchase of WWE Monday Night RAW, the impending Taylor versus Serrano rematch, and its NFL Christmas game are driving engagement spikes. Sports streaming is a famously pricey endeavor. Rights are expensive, and payback comes largely from advertising. Netflix's bet is on tentpole moments, not quantity, but that bet has a fixed cost profile. Gaming is still the most speculative area. There are promising titles like Squid Game: Unleashed and Thronglets, but there is minimal monetization and uncertain market fit. The firm has maintained a cautious investment so far, framing it more in the form of optionality than a near-term lever. Source: Shareholder letter Localized content is Netflix's strongest worldwide competitive advantage. Shows like Adolescence (UK) and Counterattack (Mexico) have generated local resonance across over 50 markets. But there are trade-offs that come with international expansion. Reduced pricing, fragmentation of cultures, and increased regulatory restrictions--in Europe and Asia first of allreduce profitability. Netflix is expanding where the margins are thinnest. Netflix's moat, previously framed by scale and ubiquity, is eroding. It now must compete not just with Max and Disney+, but also with YouTube, TikTok, and Amazon Prime, each of which is delivering bundled value or ecosystem benefits. Netflix does not have a second business layer (such as Amazon's retail or Disney's parks), making it that much more subject to content ROI fluctuation. Netflix's valuation today extends far past industry norms and history to market medians, with the market apparently fully factoring in perfect execution. The stock has a P/E of 56.78 and a forward P/E of 47.17, each of which is in the top decile of the industry. Its PEG of 3.57 and price-to-free cash flow of 70.67 are also a reflection of how far-stretched the stock is from its fundamentals. On nearly all forward-looking multiples, EV/EBITDA of 18.88, EV/FCF of 68.64, EV/Revenue of 12.74, Netflix is valued like a capital-expensive media platform instead of a high-margin SaaS business. Its ratio of 2.04 to Price to GF Value suggests that it's trading at over twice its value. The GF Value computed by GuruFocus is $588, whereas Netflix's market cap has been trading around $1,200, which means that it is highly overvalued. Even best-case DCF estimates of $661 and modeled FCF estimates of $739 place the stock 3050% above intrinsic value. At the same time, recent Guru activity is characterized by net selling. Baillie Gifford (Trades, Portfolio) (-9.86%), PRIMECAP, Frank Sands (Trades, Portfolio), Philippe Laffont (Trades, Portfolio), and Ken Fisher (Trades, Portfolio) (-54.45%) are just a few of the notable managers that trimmed holdings through March 31, 2025. While small purchases by Jeremy Grantham (Trades, Portfolio) and Ray Dalio (Trades, Portfolio) were offset by pervasive decreases among institutional owners, the 3-year trend reveals a clear net of selling, even through the stock rose, a possible red flag. Netflix is no longer the sole bidder for the attention economy. It competes now with YouTube for short-form and creator-driven content, TikTok for younger audiences, as well as with Apple and Amazon for bundle benefits. Even within SVOD, Disney+ and Max are consolidating, providing sports, lifestyle, and entertainment bundles that concentrate spending by consumers on fewer platforms. Netflix's greatest challenge is not competition, it's that its foundational advantage of scale of content is being eroded by content fatigue. More is not always better, and not all hits translate. But bundlers like Amazon subsidize with commerce, and Disney has a park and merchandising ecosystem. Netflix doesn't have such adjacent business ecosystems, so it is more vulnerable to a shift in content ROIC. The firm is further confronted by mounting political headwinds. With its viewership spread across more than two-thirds of its customers outside of the U.S., Netflix must now contend with international regulation, content quotas, and increasing digital nationalism. These threats do not necessarily manifest themselves on earnings for several quarters, but could ultimately limit its monetization potential or create regulatory drag on the margin. Source: Nielsen Netflix is implementing an ambitious shift, becoming a complete-stack entertainment company across content, advertising, live, and interactive. But whereas its strategic plan makes sense, its valuation is predicated on execution excellence across all vectors, margin growth, scaling monetization, as well as continued subscriber growth. The vision of future Netflix would actually materialize, but at the current price, the market is already paying for it all. Investors would do well to watch out for monetization conversion from ads as well as live content, margin control through H2 2025, as well as compounding of FCF, as valuation based on beliefs doesn't take surprises generally. This article first appeared on GuruFocus. 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