Blogs

‘Stranger Things’ happening to Netflix, quite literally!


  • Is subscriber growth miss in Q2 2019, a big concern for Netflix investors?
  • Will Netflix be able to revive its investors’ confidence in H2 2019?

 

July 17, 2019 was rather eventful for Wall Street as well as for Netflix. The world’s largest internet streaming firm shook the market when it released its Q2 2019 results, reporting a decline in its domestic paid subscription for the very first time since 2011 and an overall miss in its quarterly subscriber growth numbers. In return, the market stunned the firm with a monstrous 11% decline in its share prices in a single day.

Netflix Q2 2019 results reported that it missed analysts’ expectations as well as its guidance for the net adds in paid subscriptions. During Q1, the company forecasted its Q2 net addition to global paid subscribers at ~5 million, while the actual addition was merely 2.7 million, which was nearly half of the forecast. In the domestic market (US), the net addition declined by 0.13 million, while in the international market, it grew merely by 2.83 million. For a company that is primarily dependent on subscriber growth (the sole source of revenue), this decline appeared disastrous to the market.

The primary reasons for this decline were price hike and relatively weak content slate in the second quarter. The company acknowledged in its Q2 2019 earning call that though the slowdown was witnessed in all regions, the increased churn rates and reduced retentions were mainly seen in regions where prices increased. Another key factor that was responsible for this significantly weak subscriber growth in Q2 was a pull forward in Q1 from Q2 as Q1 was an excellent quarter for the company, the net addition in subscribers’ number was 9.6 million against 8.9 million expected.

The instant reaction by the market, leading to a whopping 11% decline is understandable as the market primarily runs on sentiments, however, the correction should have soon followed because this was not the first time it has missed its Q2 guidance. The historical trend reveals that this miss in Q2 is cyclical in nature, primarily because of the warmer weather and longer days that keep viewers engaged in other activities. Netflix has missed 3 out of 4 second-quarter results since 2016. After each of these misses, the company has always bounced back and is expected to follow the trend this year as well. Nonetheless, the share price decline continued for the company and Netflix lost approximately $31 billion in value since its earnings release. Although, the market should absorb the fact that the US has broadly saturated and international markets will drive majority of the growth going forward.

On the other hand, the bond market and analyst community are not so negative on its Q2 results. Though the company’s debt also weakened during the next trading day of the release, however, the largest dip was merely 2.5%. ‘We’re not concerned. We’re still keeping to our forecast’, mentioned Neil Begley, Senior VP at Moody’s Investors Service. Hence, this relatively marginal drop in its bond value confirms the view that Q2 miss is relatively an inconsequential event.

Similarly, analysts also view this as a buying opportunity as they are still positive about Netflix on meeting its FY 2019 guidance, driven primarily by the addition of new and exclusive content in H2 2019. The release of Season 3 of ‘Stranger Things’ has already broken few viewership records, but its impact on subscriber numbers and revenue was not captured in Q2 numbers as it was released on 4th July 2019.  ‘Early 3Q trends are strong, led by Stranger Things S3, and we believe churn rates have receded closer to pre-price increase levels’, said J.P. Morgan analyst. ‘We View This ‘Miss’ As A Buying Opportunity’, stated Deutsche Bank analyst.

Furthermore, the net impact on revenue (increased by 9% Q-o-Q highest in last 4 quarters) had been positive despite the decline in subscriber numbers, which is a temporary issue given a stronger content slate in H2 of the year. Further, given the nature of the business, deceleration in a single quarter should not be considered as a reflection of permanent decline as viewers keep switching back and forth between available options.

Hence, despite missed expectations in Q2, Netflix is expected to pull off its FY 2019 guidance driven by ‘Stranger Things’ and other such shows.

Nevertheless, the real struggle might begin next year when the competition gets stronger as many new players will enter the market, posing a threat on its licenced content. Disney, Warner Media and NBCUniversal will launch their streaming services by early next year. It is due to this that Netflix will lose some of its bestselling licensed products such as ‘Friends’, ‘The Office’ as the owners have decided not to renew their contracts and reintroduce these shows on their streaming services. Though the management is positive that it can use the set aside amount to create more original content. However, this is still a riskier option as the success probability of the original content is lower than the already popular shows, unless the team comes up with more of a ‘Stranger Things’ kind of content.

Another worrisome area is the mounting debt. Netflix’s total debt has increased by more than 50 times since 2011. In the last eight years, its net debt to equity jumped from -.93x (2011) to 1.25x (2018). On the other hand, its coverage ratio has declined from 20x to 4x during the same period.

While it is still the best performing company in the industry, investors should be wary of its ever-increasing debt numbers.

In a nutshell, subscriber growth missed in Q2 should be considered as a temporary blip since Netflix is bound to bounce back in FY2019 results. However, in the long-term, a growing competition, escalating debt and domestic market (US) saturation could become a cause of concern for investors. Nonetheless, Netflix should still be able to rebuild investor confidence if it creates strong content slate, particularly from originals category, more meticulously manage its debt and strategically target the non-US markets.

Your Rating

Slack set out to kill E-mail

Started as a side project for internal use in a gaming company High revenue growth with recurring revenues Went Public by offering shares through the Direct Public Offering ...

Will the Big Bang merger drive, of Indian Public Sector banks, provide the required impetus to the slowing economy?

India’s Government announces plans to merge 10 of the country’s public sector banks Probable impact of the mergers   India’s Finance Minister, Nirmala Sitharaman,...

Is Mothercare on the verge of collapse?

History of Mothercare What went wrong? Company moved into administration   Mothercare, an iconic brand for babies, children and parents to be, went into...

Rapidly growing Indian online food delivery industry and its unrealised profits

Evolution of online food delivery industry in India Geographical penetration and scope for expansion Key players and their zeal to balance revenue and costs   Online...

Tire manufacturing industry, analysing the cost and margin trends

The global market for tire manufacturing stands at $180 billion. Michelin anticipates the long-term demand to rise at the rate of 5 to 10% a year in developing markets and 1 to 2% a year in mature...