IAM-photography
This article was originally published for members of Leads From Gurus.
Netflix, Inc. (NASDAQ:NFLX) stock is down 69% year-to-date, making it the worst-performing stock in the streaming sector. For the first time in almost a decade, the company lost 200,000 subscribers in the first quarter. This is not going to sound exciting, but Netflix also expects to lose an additional two million subscribers in the current quarter as well (Q2 earnings are expected on July 19). The streaming industry remains fiercely competitive, with companies investing billions of dollars in original series and movies, as well as promotions. As the popularity of streaming media grows, many traditional legacy media companies are on their way to adopting recurring-revenue subscription models, and more new streaming services are emerging. The intense competition, macroeconomic challenges such as inflation, and the Russia-Ukraine war continue to be major roadblocks for Netflix.
Even though every streaming company is experiencing slow growth as the pandemic-induced surge has passed, why is Netflix the only streaming behemoth losing investor confidence? As an investor of the company, I had to stomach the massive dip in the stock price following Q1 earnings, and I’m sure many of you had to remain strong as well. Is this a transitory slowdown in growth? Fellow contributor Victor Dergunov certainly believes so but can we simply wait and do nothing until Netflix recovers? Better yet, is Netflix truly so cheap to the extent that we can boost our holding? In this article, we will try to find answers to these important questions.
Why Does Subscriber Growth Matter To Netflix More Than Any Other Streaming Company?
Netflix differs from other streaming and entertainment giants such as Disney+, Apple TV, and Amazon Prime in that their profitability is not entirely dependent on on-demand video streaming services and subscriber growth. Indeed, their entry into the streaming industry was one way for them to improve customer retention for their more profitable businesses.
Netflix, on the other hand, dominates the streaming and online entertainment industry, and its ability to maintain that position is entirely dependent on subscriber growth. Although Netflix remains one of the world’s largest streaming media companies, current economic challenges, and some of its persistent challenges such as password-sharing, are weighing on the company’s growth. In addition, spending on content creation, production, and marketing is also a challenge. During the pandemic, individuals were looking for entertainment options while being forced to stay in their homes, so “Netflix and chill” seemed to be the easiest way for them to get entertained while adhering to mobility restrictions imposed on them. It’s certainly not the same today, and the recent loss of subscribers suggests some consumers are finding online streaming services a burden on them.
For Netflix to retain its dominance, the company must either continue to invest and launch new content on a regular basis or find alternative ways to prevent subscriber churn such as licensing content from other media houses and introducing lower-priced subscription tiers. If you think about this situation carefully, it would not be difficult to realize that Netflix is stuck in a difficult place – the company certainly cannot cut down on content production or licensing costs and risk losing its dominant position but at the same time, subscriber losses will continue to hurt in the short run, meaning operating margins will face headwinds.
Netflix’s Content Strategy Needs Some Work
What benefitted Disney+ from its launch to this date is the massive content library the media giant already had access to. Using the Disney+ subscriber growth pattern as a reference, we can see the platform sees a surge in subscribers after the release of must-watch content, and the rate of new subscriber additions drops within 4-6 months after the release of these most awaited titles. To make the most of this pattern, Disney+ has adopted a strategy to phase the release of high-demand content in a way that maximizes new subscriber additions.
If you look closely at the recent performance of TV series and movies, it becomes obvious that family-oriented content, periodic drama, and documentaries appear to perform well on OTT platforms. Netflix’s previous quarter’s big hits included Bridgerton Season 2, which had 627 million watch hours, The Adam Project, which had 233 million watch hours, and Inventing Anna, which had 512 million watch hours. What Netflix lacks in terms of Disney+ is a well-defined strategy to phase the release of popular titles to maximize subscriber growth, which was not a problem in the early days of Netflix’s OTT journey as subscriber growth was bound to remain positive no matter what. Today, however, failure to plan the releases of most awaited titles to lure subscribers will result in unwanted volatility in subscriber additions, which is exactly what we are seeing today.
There’s another problem to address. Netflix was and is known for having an expansive content library that includes as many genres as you could possibly imagine. This strategy worked well during the startup and growth phases of the company but now, the company should ideally invest in focused content that is in high demand. It’s not about scrapping certain genres altogether, but about streamlining the content slate to focus more on titles with a high hit rate than releasing content at a rapid pace for to expand its content library.
The good news is that Netflix has already identified the need for a revamped content library, so possibly, the company will address these issues in the coming quarters. Netflix is also investing in its recommendations feature once again, which is another positive sign in my opinion as this was one of the biggest strengths of the company that differentiated it from competitors in the past.
Challenges Netflix Has Already Identified
During the Q1 earnings call, the company said that growth is being hampered by four primary interconnected factors. First is the prevalence of the password-sharing model. According to the company, 100 million households utilize its services but do not pay for them, accounting for nearly half of its global paid membership base. Although account sharing increased brand exposure and the number of individuals watching content in the past, it has now become a major roadblock to growth that the company must overcome.
According to Netflix, the company might lose up to two million subscribers in the second quarter as it works on a password-sharing function. Netflix launched two new paid sharing capabilities in three markets in March as part of its efforts to prevent password sharing among households. Netflix CEO Reed Hastings, on the other hand, believes that monetizing account sharing will drive ARM and revenue growth. Although this effort could put more pressure on subscriber additions in the near term, Netflix has been able to attract and maintain subscribers for many years even after boosting membership prices. This characteristic suggests Netflix will indeed benefit from the introduction of a subscription tier that supports password sharing. The important thing here is that the company’s goal should not be to chase away users who share passwords but rather to convert them into paying subscribers at a cost they are willing to pay. Netflix seems to be moving in the right direction from this front.
The company is considering a lower-cost plan with advertising, which would create an additional revenue source for the company while giving customers more flexible options to subscribe to Netflix. This is something that I have discussed in the past as well. To be successful in densely populated and strategically important regions such as India and Latin America, Netflix needs to introduce ad-based subscription tiers. These types of business models have already seen massive success in India as consumers are ready to embrace commercials during streaming as long as subscription costs remain reasonable and budget-friendly.
The second factor is the intense competition, which is not something that will leave a long-lasting impact on Netflix’s earnings, in my opinion, because of the long runway for growth globally.
Third, the company stated the recent price changes cost 600,000 customers in the United States and Canada this quarter. Finally, the loss of subscribers was also the result of a suspension in services in Russia due to the ongoing crisis, which, according to the company, resulted in the loss of 700,000 subscribers.
Challenges That Go Mostly Unnoticed
The growing number of binge-watchers is not good for the viewers or the company. According to Forbes, in January 2020, 8.4 million users tried to finish a series within the first 24 hours of release. This was before the pandemic and one can only imagine that this number has increased ever since. Other than the ‘overnight watchers’ group, on average, an individual finishes a series within 4-5 days. Given the speed at which people can finish watching a series, online entertainment platforms will have to double the speed at which they publish content, which would lead to a doubling of the expenses related to content production. Binge-watching was a boon for Netflix a few years ago because the competition was low and there was enough content for binge-watchers. In 2022, there are more binge-watchers than content because of the shift to hybrid work and work-from-home culture. This trend will continue, so streaming media companies need to strategize the time and type of content to publish. The timing of the launch is just as important as the type of content.
Streaming giants are not just competing with each other to stay on top of the content game, they are also competing with Instagram Reels, TikTok, and YouTube. These platforms provide regular content at low to zero cost with various options that are more appealing than paying to watch the most-talked-about series of the month. The expanding social media and creator economies are challenging streaming service providers in attracting and retaining young consumers. Considering this challenge, Netflix India is collaborating with some of the most popular Indian YouTubers, saving significant costs in creating and publishing content.
The third challenge, and one that is becoming crucially influential, is the importance of cultural reference. What made Bridgerton Season 2 an instant hit in India is the first-time appearance of South Asian actresses in the lead role of a Netflix English series. Furthermore, the emphasis placed on details of Indian culture such as clothing, the use of the iconic Bollywood film KKKG theme song, and tea ingredients received a lot of appreciation. Unlike other period dramas, Indian consumers loved this one for the simplicity of the story and more importantly, for having an indifferent view of every character, whether English or South Asian. Failure to keep up with the bar set here will be an obstacle to the company’s growth in India, which Reed Hastings famously claimed as the most important market to conquer.
The investment thesis remains valid
Netflix has hit a roadblock after a decade of rapid growth. In the first quarter, the streaming giant lost 200,000 customers internationally, and it predicted even more difficulty in the current quarter. Due to a high number of households sharing accounts, competition, content blockage, inflation, and political turmoil, the company is having difficulty retaining existing subscribers and acquiring new users. The loss of subscribers might be daunting for investors, but continuous pandemic-related challenges, global conflicts, and the shifting work economy will continue to have a medium-term impact on every industry, which is something that we all have to come to terms with.
As mentioned before, Netflix purely relies on streaming video-on-demand services and as the company invests in improving the quality of content and user experience along with changing its decade-old model of account sharing, investors can expect sluggish growth in the current quarter. However, the company still dominates the streaming industry and management plans to reaccelerate growth by doubling down on content development and adding more features to its user interface.
In addition to this, the company has unveiled a new strategy to win subscribers in India, which the company is yet to publicly discuss. As I reside in Dubai, which is densely populated with Indians, I got to know that the company is increasingly collaborating with Indian studios to bring new movies to Netflix just a few days after theatrical releases, which is a very promising development. For example, Gangubai Kathiawadi, one of the most awaited Hindi movies this year, was released on Netflix less than two months after its theatrical release, which is something that does not often happen when it comes to Indian movies. The same was true for many other popular hits such as Jersey, Radhe Shyam, Bhool Bhulaiyaa 2, Anek, RRR, and Major. This strategy, according to my sources in India and the Middle East, has already won the praise of many locals who are now comfortable paying for a Netflix subscription to get early access to new movies.
Takeaway
In 2022, Netflix stock is unlikely to deliver meaningful returns, but the company’s growth story is far from over. Netflix – or any other streaming platform for that matter – is yet to penetrate global markets meaningfully, and the next decade will offer ample growth opportunities for all the leading streaming companies in the world. Netflix may take some time to recover from the sluggish growth seen in the recent past, but as things normalize in the post-pandemic era, I believe the company will return to a phase of subscriber growth resulting from its efforts to tap into international markets. At just 17 times forward earnings, Netflix is no longer valued as a hyper-growth company, but I believe the market will be proven wrong in the coming years.
Be the first to comment