In the middle of another summer results season, the outlook for many media and tech companies – like many other sectors – is generally positive.
But bucking that trend is behemoth Netflix, where net subscriber additions – the bread and butter of the business, after all – missed analyst expectations by around a quarter of a million.
Earnings and revenues were also below expectations and the forecast for Q3 subscriber growth was some 2m lighter than that predicted by analysts pre-results.
In short, though it’s always difficult to discern long-term trends from one quarter’s numbers, things do not look great for the company as it stands.
One big issue is the geographical mix of subscribers – with much of the growth driven by Latin America and Asia-Pacific.
Subscribers from these areas generate much less revenue per subscriber than North America and Europe – nearly half in the case of Latin America. North American subscribers fell in the quarter by c. 430,000 and Europe had sluggish growth with c. 190,000. If subscriber growth is weighted more towards these newer areas moving forwards, then one of the two main engine drivers for Netflix’s model – Average Revenue per User (ARPU) – will be pulled down progressively.
North America’s subscriber decline also feeds into a worrying narrative of whether streaming growth is reaching saturation point in the United States.
True, as Netflix highlighted, it has been here before. However, recent Kantar data suggested only 3.9 per cent of households added a new TV subscription service in Q2, with penetration rates of US households staying flat at over 75 per cent of households.
There is a question now whether the United States is, in effect, a low / no growth market for streaming. Netflix’s response is that, with only 7 per cent of TV viewing in the US, there is a long runway to growth but there are signs linear TV viewing (with 63 per cent of US viewing) may be more resilient than expected.
The obvious counter-argument to this gloomy prognosis is to say “yes but Netflix could grow its revenues per subscriber in faster growth areas, while developing new revenue streams such as gaming.”
However, both those arguments have flaws. The largest market in Asia Pacific is India (China is out of bounds for non-Chinese streamers), which is extremely competitive and where price increases are hard to sustain. Large price increases in Latin America are probably out of the question and, even in the US and Europe, while churn remains low, there is a limit to how far Netflix can push pricing.
As for new revenue streams, Netflix made it very clear it sees gaming more as a way to both reduce churn and to help increase its reach on mobile, rather than as a major new pillar of growth. As for introducing advertising, the message remains loud and clear that this is unlikely to happen (which I think is the smart thing to do). Management may change their minds in the future on both these points but, for the moment, the existing model is the one with which they must play.
The main issue shares-wise is that Netflix’s market capitalisation is c. $230bn. You need a lot of future growth to justify that valuation. If Netflix starts disappointing on a more regular basis and investors’ faith in management declines, do not expect such a valuation to hold. The next few quarters will be crucial.