Netflix Inc. (NFLX, Financial) undoubtedly has been a major beneficiary of the disruptions that have wracked the global economy in 2020. With large swathes of the population either out of work or working from home, the streaming content giant was bound to do well on the subscriber front. Netflix was further boosted by the months-long lockdowns and ongoing quarantines, which curtailed the range of alternative forms of entertainment.
Unfortunately, the tailwinds that Netflix has enjoyed in recent months have not erased its struggles. The brief reprieve they were offered may be approaching its end.
Subscriber growth faces headwinds
On Sep. 29, Wells Fargo released its latest outlook for Netflix's third quarter. According to analyst Steven Cahall, "typical Netflix monthly churn is impressively low at 3.5-4 percent." But subscriber pull-forwards in the first half of the year, as well as the public outrage sparked by the release of the controversial film "Cuties" in September, may have acted as serious headwinds:
"[September Churn] might have reached levels that were some eight times August's churn rate...If we assume that churn increased five times for a single week due to Cuties, it implies…28 million deactivations in the third quarter. We're not sure that gross adds will be up sequentially given the first and second quarters 2020 likely benefited from lockdowns and a lack of live content elsewhere. As such, our churn sensitivity analysis suggests negative net adds are a possibility (especially if churn exceeded 5 percent)."
Based on this analysis, Wells Fargo cut its forecast of third-quarter global subscriber growth forecast in half to 2.5 million, with the domestic market especially impacted. While Wells Fargo had previously expected Netflix to add 500,000 new subscribers in the U.S. and Canada during the quarter, it now forecasts a loss of 2 million.
Growth narrative faces pressure
Heading into 2020, Netflix was already facing mounting scrutiny thanks to stalling domestic subscriber growth. A growing number of analysts and investors had begun to question the growth narrative at the heart of Netflix's vaunted valuation. Based on Netflix's performance n the domestic market in 2019, such fears were well justified, as Hedgeye's Andrew Freedman observed on Jan. 23:
"U.S. sub growth hit a wall in 2019 while linear TV sub losses accelerated to the downside. Runs counter to the bull thesis around cord cutting freeing up wallet share and incremental subs."
Thus far, Netflix has managed successfully to divert focus away from this less than exciting domestic situation by pivoting its rhetoric and shifting investors' attention toward its still growing international subscriber markets. Whether the company can continue to succeed at downplaying or distract from its mounting domestic headwinds is far from certain.
My verdict
Even a small shrinkage in Netflix's domestic subscriber base may be viewed as a serious cause for concern among investors. Its market capitalization of $232 billion reflects an expectation of many years of wild growth. While domestic subscriber counts have stalled, the international market may yet offer some relief. But saturation is as inevitable abroad as it is at home.
My advice to investors is to handle this name with care, especially as its optimistic story collides increasingly with a more pessimistic reality.
Disclosure: No positions.
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