Netflix: Lockdown Subscriber Boost Won’t Last

Netflix Inc. (NFLX) reported earnings for the first quarter on April 21. Investors had been hoping for a big boost for the streaming video company thanks to the lockdowns and quarantines that have kept consumers indoors for more than a month.

As it turned out, the first quarter proved to be a mixed bag for Netflix. While the streaming giant surprised investors with strong subscriber growth, there may, upon closer inspection, be less than meets the eye to that particular beat.

Strong headline growth

Netflix reported a staggering 15.77 million net new subscriptions in the first quarter, blowing away both the FactSet estimate of about 8 million and its own prior guidance of 7 million.

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With most people stuck at home during a veritable worldwide economic lockdown, it was reasonable to expect that streaming video services would experience a boost. This was what the market had evidently surmised, as investors proceeded to bid up Netflix’s stock to pre-crisis levels in the week before the earnings report.

As it turned out, even the most enthusiastic of bullish analysts underestimated the growth rate. On April 16, Goldman Sachs (GS) assumed the mantle of Wall Street’s leading Netflix bull with the publication of an updated forecast. Yet, even Goldman, for all its enthusiasm, could only bring itself to forecast subscriber growth in excess of 10 million.

Removal of weekly subscriber data

Analysts were left scratching their heads as they reviewed the company’s latest shareholder letter, which omitted some data that had been shared regularly in prior quarterly reports. Of particular note was the exclusion of weekly subscriber cadence, which had been included in chart form in previous shareholder letters.

Several analysts were discomfited by the loss of the weekly subscriber chart, including Hedgeye’s Andrew Freedman, who took to Twitter to lament the move. Freedman said he was “really disappointed” by Netflix’s decision to remove such a “helpful disclosure” from its report.

This is not the first time Netflix has decided to stop reporting potentially unflattering data points. On April 22, The Entertainment Strategy Guy, an entertainment industry executive who writes frequently on the subject of streaming media, offered an especially scathing assessment of this Netflix proclivity:

“Why did Netflix pull the weekly subscriber chart? It's really helpful, and now it's gone. Another data point in the trash heap of dead Netflix data points.”

Management did touch upon weekly subscriber cadence during Netflix’s April 21 analyst conference call, saying it was in line with numbers seen in past first-quarter periods. Still, the decision to exclude this from the report is of concern to me.

Changes to subscriber aggregation

In another unusual move, Netflix did not break out subscriber counts between the U.S. and Canada markets, instead providing only the aggregate figure. 

In my view, Netflix’s decision to aggregate its U.S. and Canadian subscriber numbers may have been taken in an effort to downplay the increasingly evident slowdown of the domestic market. While this may help Netflix preserve its growth narrative, which has refocused in recent quarters on the international market, it cannot conceal the growing reality of domestic market saturation.

My verdict

While management attempted to cast Netflix’s first quarter results in an overall positive light, they were forced to admit that the unexpected jump in subscribers was effectively a demand pull-forward, which will likely dent subscriber growth going forward.

I view Netflix’s move to aggregate subscriber data to downplay domestic market saturation, as well as its decision to cease reporting useful weekly subscriber cadence data, as indicative of weakening internal expectations. If this is the case, the Netflix growth story will come under increasing threat.

Moreover, Netflix continued to fall short financially in the first quarter, despite its big subscriber growth surprise. Netflix’s revenue print was in line with analyst expectations, coming in at $5.77 billion, but reported earnings of $1.57 per share fell short of the expected $1.61.

In sum, Netflix fell short financially, even with a major subscriber demand pull-forward and lockdown-related tailwind. With growth set to slow in the coming quarters, I expect Netflix’s lofty valuation to face intensifying pressure.

Disclosure: Author is short Netflix.

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