Netflix Inc. (NFLX, Financial) made waves in January when it announced that it had handily beaten analysts' revenue and subscriber growth expectations in the final quarter of 2020. While the company fell short of expectations with regard to profitability, bullish investors' fears were quickly assuaged by the streaming media pioneer's revised forward guidance, which projected positive free cash flow from 2022 onward.
On April 20, Netflix will once again be under analysts' microscopes as it reports earnings for the first quarter of 2021. Whether the company can once again dazzle analysts and investors remains to be seen, but a number of emerging trends have caused growing concern among observers.
Competition threatens subscriber growth
2020 saw the so-called "streaming wars" between incumbent Netflix and a host of new entrants to the streaming market heat up to a whole new level of intensity. As Bloomberg reported on April 18, competition has already eaten away at Netflix's vaunted market share:
"While Netflix is still far and away the dominant player, its market share is in decline. Two years ago, Netflix accounted for 64.6% of demand. The decline is even steeper in the U.S., where Netflix accounted for 48.1% of demand, the first time it's ever been below 50%. (This may have something to do with Netflix's more limited output in the first quarter of the year, though that doesn't explain the two-year trend.) A report from Ampere Analysis painted a similar picture. Netflix's share of subscribers in the U.S. has dropped 31% in one year."
Netflix's biggest emerging rival is Disney+, which was launched by the Walt Disney Co. (DIS, Financial) in November 2019. When Disney+ first came on the scene, Disney set a goal of reaching 60 million to 90 million subscriber within five years. The entertainment giant has already blasted through the high end of its target subscriber range in just one year, with 94.9 million streaming subscribers reported at the end of 2020. As I have discussed previously, Disney represents Netflix's greatest threat in the streaming wars. Indeed, it may even overtake the market leader this year.
New content funnel drying up
Another issue facing Netflix that could end up impacting both profitability and subscriber growth is the depth of its content funnel. Specifically, Netflix has fallen behind the pack in terms of bringing new content onto its platform in recent months, which media industry analyst The Entertainment Strategy Guy flagged as a potentially serious issue on April 17:
"The overall decline in total new Netflix shows (original and licensed) has led to the general decline in viewership. Essentially, Netflix produces at an average or below average rate, so they need volume to generate hits. In other words, the idea that 'data' and 'algorithm' translate into a better ROI on producing shows and films would be inaccurate. If data helped make better shows, presumably you'd see better shows...To be clear, I'm saying the production delays SHOW how Netflix needs volume to get hits."
In other words, as Netflix has dialed back the flow of new content to its platform, overall viewership has suffered. That could prove especially problematic should streaming rivals continue to press from all sides, as they have been doing for the past year. Without fresh content to keep subscribers interested, Netflix risks losing subscribers. Fears of declining subscriber counts are hardly new, especially in Netflix's most saturated markets such as the United States.
With a market capitalization of $244 billion, Netflix is currently valued as if it will eventually deliver many years of truly spectacular growth and positive cash flow. In its fourth-quarter earnings report, Netflix guided for $7.1 billion in revenue in the first quarter and earnings to the tune of $2.97 a share. The company also said it expected to add 6 million net new subscribers during the quarter.
If Netflix does not show sustained subscriber growth and interest in its upcoming earnings report, some investors may begin to question its vaunted valuation. While a slowing content production and licensing cadence may reduce some costs, it also risks chipping away at Netflix's subscriber base. That in turn may undermine its plan to achieve sustainable profitability and cash flow going forward.
As I see it, Netflix is still being valued as if it will always be a dominant player in the streaming media market. With Disney already hot on its heels, and many other streaming services building audiences of their own, that optimistic future has never looked more uncertain in my opinion.
Disclosure: No positions.
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