Netflix (NFLX, Financial) is not just a company – it is a cultural phenomenon. In the span of just a few short years, the digital streaming service has utterly reshaped the film and television industry, eradicated the video rental market and forged a sparkly new standard by which all other tech companies are now judged.
For better or worse, Netflix has become part of the American story – and that is why investors are starting to get a little worried.
Although Netflix has been around for a while, it has only started to gather steam over the last couple of years. Numbers have understandably soared thanks to the introduction of shockingly high-quality original content, an ever-improving and responsive platform and a rapidly increasing media database. In January 2012, Netflix had around 24.4 million U.S. subscribers. As of July, 47.1 million Americans now subscribe to the service.
As a point of reference, that is about one in six Americans – and therein lies the problem. How much room is left for the company to grow?
If Tuesday’s second quarter report is anything to go by, the answer is "not a lot." It has not taken investors long to suss that out, and so they are now doing their best to get the hell out of Dodge. Share prices have already plummeted 15 percent as a direct result of that exodus.
To be honest, that is not really a bad thing.
First and foremost, let's point out that Netflix is a profitable business. Despite this fresh spate of pessimism, the company has just posted a 28 percent hike in revenue for the quarter – equating to $2.1 billion. U.S. revenue has shot up 18 percent year over year, with domestic ASP growing by 4.5 percent. International losses are shrinking, and the company’s costly original programming has started generating all sorts of awards buzz.
But that monomuntal financial success has got little to do with subscriber growth. If anything, it is because Netflix has finally decided to implement some long-delayed price hikes across many of its top markets. But anger over those increases has predictably led to a rise in cancelations and chased loads of users into the arms of Netflix's formidable rival, Amazon (AMZN, Financial).
And while more and more users are choosing to abandon the platform, less and less individuals are being lured into new subscriptions. Last quarter, Netflix fell well short of its global member forecast of 2.5 million additions, instead adding just 1.7 million members. Any other digital streaming service might salivate at those numbers. Yet it is worth bearing in mind that the company we are talking about posted a net addition of 3.3 million members this time last year.
Things are slowing down particularly fast in America. Although profits are up, Netflix posted a net addition of just 160,000 U.S. members for the second quarter of 2016, against a forecast of 500,000. You can understand why investors might worry a bit about that slowdown, because the U.S. represents approximately 34.3 percent of all the company’s business.
CEO Reed Hastings does not think slow U.S. growth has anything to do with market saturation – the logic being that numbers are also plateauing in developing international markets. Yet the company’s unambitious third quarter forecasts kind of suggest otherwise. In the U.S., Netflix is hoping for a net addition of just 300,000 members. Internationally, the company is expecting around two million.
Those projections appear to be somewhat realistic and in keeping with market trends. But it is also worth pointing out that Hastings and his team are anticipating a few more price hike tremors to take place across the coming months. If numbers are down across the board, and we know that price hikes generally chase away customers, can we realistically expect incredible growth in the quarters to come?
Probably not – but that's OK.
Investors have got to stop looking at Netflix like some sort of cash cow that is able to spew out a quick buck every quarter. A period of rapid growth has attracted far too many investors for all the wrong reasons, and now that Netflix has predictably hit a wall in terms of user growth, they are all jumping ship. The company was probably trading too high for its own good, anyway. Additionally, there is no reason to believe this week's price drop will actually put a dent in the company's profitability. It will simply chase away the non-believers.
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At the end of the day, Netflix is a successful business. The company is a valuable investment that is always making money, and its unrivalled platform and award-winning original content alone will solidify its long-term sustainability. But if you want to invest, do your fundamental research and know what you are getting into. Buying shares in Netflix is not a bad move, but it definitely will not score you an early retirement.
Disclosure: I do not own shares in any of the companies listed within this article.
