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Home / Business / Netflix just failed a great test – The Motley Fool

Netflix just failed a great test – The Motley Fool



Six months ago, I described 2019 as a "make-of-break year" for streaming video pioneer Netflix (NASDAQ: NFLX) . The company was in the midst of rolling out its most ambitious price increase for almost a decade – barely more than a year after a previous price increase. If it had been able to do so without a major impact on subscriber growth, Netflix would have shown massive pricing power and supported its high valuation.

Instead, subscriber growth slowed down last year, as revealed in Netflix's recent performance report. This is a big red flag for investors, as it suggests that Netflix's older markets are beginning to reach saturation and that significant price increases can drive customers away.

Balancing price increases with subscriber growth will be even more difficult in the future, with a drop of rivals including Walt Disney (NYSE: DIS) set to launch new streaming services soon. As a result, the Netflix share does not appear to be appealing even after falling by about 10% on Thursday.

 NFLX Chart

Netflix Stock Performance, data by YCharts.

Growth approaching almost

Netflix had solid performance in the first quarter of 2019. While revenue growth slowed down and operating margin declined the following year, the company reported a record 9.6 million net paid subscriber subsidies in the quarter.

However, in the context of the revenue report, Netflix estimated that net paid subscriber growth would fall to just 5 million in the second quarter. It would have been lower than the 5.45 million paid subscribers added in the previous period, which was a disappointing result.

Reality was far worse. Paid net premium came in at just 2.7 million last quarter, down more than 50% year on year. This included a slight decline in Netflix's domestic paid subscriber count – the first drop since the company's unsuccessful attempt to rewind its DVD-by-mail business as a new company called Qwikster back in 2011. Globally, Netflix saw the most underperforming market where it recently increased prices.

To be fair, Q2 is always the weakest part of the year for subscriber growth. Netflix continued the quarter with its global paid subscriber counting 22% year on year. It also acknowledged that it had a relatively weak slate with new content last year, and Netflix delayed some marketing expenses for the second half of the year. All of these factors can help explain the subscriber party last quarter. However, the poor quarterly results are not good for Netflix bulls.

Why the decline seems important

Globally, Netflix is ​​still growing fast. Turnover increased by 26% last year, despite the negative impact of the negative dollar exchange rate. Netflix is ​​still relatively new to many of its markets, and therefore it appears that the general growth figures look quite strong.

  A Netflix content screen for the Stranger Things

Netflix is ​​now relying on international markets for the majority of subscriber growth. Image source: Netflix.

But in the United States there are clear signs that Netflix reaches maturity. The company had 60.1 million paid subscribers in the US at the end of last year, up only 7.4% year on year. By comparison, the domestic paid subscriber base increased 11.2% during the previous 12-month period.

The result is that Netflix must rely on increasing prices to continue increasing domestic sales at double-digit pace. It will be even more risky as a competitive force. In April, Disney announced it would cost its new Disney + service at just $ 6.99 per month (or $ 69.99 for an annual subscription), dramatically undercut Netflix.

Of course, many Netflix subscribers are very loyal and accept annual price increases. Furthermore, many people will subscribe to several streaming video services, so there will be no zero-sum match between Netflix and Disney +. But some customers can skip the ship for cheaper entertainment options if prices continue to rise. Netflix risks being caught in a cable-like quagmire where annual price increases lead to slow but steady breakdown in subscriber numbers.

An even bigger problem for long-term investors is that many of Netflix's international markets are just a few years behind the US in achieving maturity. Netflix international sales increased by 32.6% last year, but it had increased almost 65% year-on-year in Q2 2018. International growth will continue to moderate in the years to come.

The forecast is not good enough news [19659009] Netflix is ​​planning a much stronger slate in the second half of 2019. It released the last season of the hit game Stranger Things earlier this month, the last season of Orange is the new Black coming later in July and other key titles are set to launch in the coming months. The result is that management expects stronger subscriber growth over the next few quarters.

Netflix Q3 forecast requires 7 million net paid subscriber grants, roughly flat year over year. For the entire year, the company still expects to add more paid subscribers than it did in 2018. This may indicate that the decline in the quarter is nothing to worry about.

It is true that investors should not read too much into a quarterly report. That said, Netflix's domestic growth rate has been slow for a long time. Furthermore, although Netflix achieves a year of higher net pay increases, its growth rate will almost certainly be lower in percent. Furthermore, the company is launching a cheaper mobile plan in India in the quarter – allegedly priced at less than $ 4 a month – which can inflate subscriber growth without adding much revenue.

Netflix undoubtedly has great growth over it, especially in international markets. However, the Q2 report provides even more evidence that Netflix's growth prospects are not sufficient to justify the valuation (currently close to $ 142 billion), given that the company is still away from achieving the cash flow breakthrough.


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