- Netflix loses 1M subscribers and guides lower
- Ad-supported model coming – but will it deliver incremental revenue?
- What Netflix must do to avoid becoming the next “Blockbuster”
2022 has not been kind to technology stocks.
And none have fared worse than Netflix (NFLX) – shedding some 63% of its value.
Over the past 2.5 years – the streaming leader has lost 40% – falling well behind the performance of the S&P 500 (in pink)
July 19 2022
Late 2021 the stock hit an incredible $700 per share – which represented a forward multiple of 60x forward earnings.
That’s a lot to pay for a company that had negative cash burn and was facing intense competition.
This year it all changed.
For two consecutive quarters NFLX has lost subscribers.
All of a sudden – its forward multiple sank from 60x to around 15x.
You might say the stock when from ‘growth’ to ‘value’… with a PE ratio closer to a telco.
As it turns out, NFLX was perhaps less “tech” and something closer to a traditional TV business with the same TV problems; i.e., the relentless challenge of retaining users with high quality content.
That said, the platform boasts ~220M paying subscribers which is ~80% more than their nearest streaming competitor (Disney).
That’s impressive.
But today there are formidable competitors which include the likes of Apple, Amazon, Google and Disney.
For example, the Top 8 streaming companies alone are predicted to spend $115B on content in 2022 – all with the goal to compete for your share of wallet.
And of that $115B – Netflix will spend around $17B (or 15% of the total market)
Let’s look at the streaming leaders result… and why the stock reacted the way it did.
Beating a Very Low Bar
Last quarter NFLX told us they were set to lose something like 2M subscribers the following quarter.
Today the market was very excited to learn they didn’t lose 2M… they “only lost” 1M.
That’s less bad.
However, looking ahead they revised their expected subs lower by 800,000 (i.e. from 1.8M to 1.0M)
So you might call it a wash.
Here’s CNBC on the Q2 earnings release:
For the third quarter, Netflix forecast it will add just 1 million new subscribers — below the 1.8 million average analyst estimate, according to StreetAccount. If Netflix follows through and adds 1 million customers next quarter, it will still have lost subscribers this year through nine months. Compare that to analyst estimates from earlier this year of nearly 20 million net adds.
Netflix announced its advertising-supported product will launch in the early part of 2023. That’s actually a delay from late 2022, when Netflix had hoped to debut the cheaper tier, according to a New York Times report from May.
In its quarterly shareholder letter, Netflix also outlined its plans to crack down on password sharing, noting it has launched two different approaches in Latin America to “find an easy-to-use paid sharing offering that we believe works for our members and our business that we can roll out in 2023.”
What’s more, NFLX told us:
- The strong U.S. dollar hit revenue, which grew 9% to $7.97 billion, below analyst estimates of $8.04 billion. Revenue would have increased by 13% without the foreign exchange impact; and
- During the quarter, Netflix culled 150 workers in May and another 300 jobs in June. The firm also said it slimmed down its real estate footprint, which resulted in approximately $70 million of severance costs and an $80 million non-cash impairment of certain real estate leases primarily related to rightsizing its office footprint
They said they “adjusted their cost structure to their current rate of revenue growth”.
Put together, it was a lousy guide from Netflix but the stock rallied on the news.
Why?
For the simple reason it was “less bad” than what was feared.
Question is… do you buy it here?
And can Reed Hastings turn the business around?
So Do You Buy It?
Despite the various headwinds facing the company – I believe there are reasons for optimism.
For example, I see 4 key pillars to restoring growth.
The good news is three of the four are underway — however one is not yet on the radar:
- The pivot to the (lower priced) advertising subsidized model;
- Cracking down on password sharing;
- Sequentially feeding new content; and
- The partnership with Microsoft to expand their user base and product offerings.
#1 Lower-Cost Ad Models
With respect to an ad-based model – it’s proven consumers are more than happy to pay a smaller fee in exchange for advertising.
We’ve consumed all forms of media (radio, print, TV) this way for decades. It works.
However, when Netflix introduces this model, the question is how many of the “premium” ~220M paying subscribers will pivot from paying “$12-$20 per month” (for an ad-free service) to maybe “$5 per month” with ads?
And whilst it could see subscriber numbers grow – it could also see some cannibalization of its existing revenue.
But what Netflix have learned in a climate of intense competition and user choice – consumers have hit their “streaming wallet limit” of maybe $15 per month.
#2 Password Sharing
Last year, Netflix believes it lost $25B for the year in terms of password sharing.
And it’s a well known problem…
This is a pathway they have deliberately chosen in order to grow subs.
However, the pivot is now on to generate revenue (with subs being saturated)
Netflix believes there are an additional 100M users they can monetize who are currently password sharing.
The model here would be similar to say Spotify where you pay a small incremental fee for each family member.
Another example are telecommunications companies. For example, Verizon offering a low-cost option of US$30 per month for unlimited data if you apply for 4 (family) lines.
The model works and will do very little to cannibalize existing revenue streams.
#3 Sequentially Releasing Content
The third pillar to growth is not one Netflix have mentioned – but is widely adopted by their competitors (e.g. HBO)
For example, who watched Game of Thrones?
I loved it and I could barely wait for each week until the new episode was streaming.
Right?
Now in order for Netflix to reduce costly churn (which has doubled in the past 12 months to around 4%) – they should start thinking about ‘drip feeding’ content like Squid Game and Stranger Things.
For example, these two titles saw almost 3 Billion hours of viewing time in a month!
Stranger Things‘ newest season recorded 1.15 billion hours of viewing in its first 28 days. And Squid Game which recorded 1.65 billion hours of viewing time in the same period.
So here’s my question:
Why “dump” all that incredibly ‘sticky’ content at once? Users will binge the entire series in a matter of days.
What’s more, I bet there are tens of millions of users who “sign up” for a free 30-day trial (all you need is a new email address) and then binge watch the entire series for free!
Netflix can reduce meaningful churn (and this behaviour) by sequentially releasing new episodes each week.
#4 Partnership with Microsoft
The forth opportunity I see for Netflix is their new partnership with Microsoft.
From mine, this could unlock many other various streaming opportunities in verticals which Netflix are not in today (e.g. gaming).
Microsoft recently bolstered their investment in gaming – acquiring Activision Blizzard – and there could be strong synergies between these two businesses.
I am not sure that this is priced into the stock and represents blue-sky.
What’s more, there is an incremental advertising opportunity via Microsoft users.
What Does the Chart Tell Us?
Further to my preface, the valuation for Netflix at a forward PE of less 20x is worth looking at.
Don’t get me wrong – this is very much a “show me” stock.
They have the potential to turn this around however they will need to deliver before the market is quick to reward them with a multiple closer to say 30x.
To the weekly chart:
July 19 2022
Technically the stock was oversold at levels of around $160 a few weeks ago (where the forward PE fell below 15x)
However, you can see how the stock “based” and found support.
Now today with the stock rallying on a lousy forward guide… that’s also a good sign the bottom is in.
Note: a good sign of a market bottom is when stocks start to rally on what would normally be considered bad news.
From here, it’s feasible we see the stock ally to an area of ~$250 (i.e. the previous major low)
However, I think that is where the stock will struggle.
Again, the valuation will be looking steep at $250 in the absence of Netflix proving they are turning the business around.
Putting it All Together
Netflix has always felt more like a traditional TV business trying to solve what are “TV problems”
That is, differentiate on quality content and monetizing the eyeballs.
Traditional TV has always done this via ads – and it looks like Netflix will go the same way.
That said, at a valuation of less than 20x forward earnings and looking at the price action – it appears most of the bad news is now priced into the stock (e.g. intense competition, customer churn, and market saturation)
However, I think Netflix has an opportunity to return to growth via each of those four initiatives.
Again, they are pursuing three of the four. However there is no sign of Netflix sequentially releasing compelling (big budget) content.
If they want to limit growing customer churn – that’s how you do it.
In closing, if your timeframe is 3 years, Netflix is worth a small position in your portfolio (e.g., less than 2%) below $200 per share.
But they will need to execute in what is a fiercely competitive market.
You might say after ~15 years – the original “TV disruptor” has now been “disrupted”
But I don’t think that will worry CEO and Founder Reed Hastings… he has no intention of becoming the next “Blockbuster”!