The Lessons Of Netflix’s Terrible, Horrible, No Good, Very Bad Quarter

Investors aren’t mad at Netflix (NFLX), they’re furious.

In the company’s first-quarter earnings report, Netflix disclosed the loss of 200,000 subscribers in the first three months of 2022—consensus expectations had been for a gain. It also warned that it would lose another 2 million global subscribers in the second quarter.

The streaming video giant had ready-made excuses for this massive misfire. Too many people are sharing accounts, co-chief executive officer Reed Hastings lamented. Also, leaving Russia after the onset of the war in Ukraine caused the numbers to look worse.

More than one equity analyst shared a more coherent explanation.

Netflix, which added tons of subscribers during the Covid-19 pandemic, is getting close to market saturation. Going forward, the company will not only struggle to add more users, but also will have to fight to wring more revenue from the ones it already has.

The steady increase in streaming competition from Disney, Amazon, HBO, Paramount and Apple has given consumers plenty of other options. The downsides of paying escalating monthly charges for a content bundle (some good, much of it bad) has finally come home to roost.

Given the economic realities of 2022—rising interest rates, stubbornly high inflation, recession fears—investors should be prepared to see similar troubles among the growth stocks that have dominated the headlines for much of the past decade. Netflix’s troubles are only a sign of more to come.

Is Netflix Out of Good Ideas?

After making excuses for horrifyingly bad subscriber losses and guidance, Netflix executives segued to potential solutions to the company’s dependency on subscription revenue.

One big idea was introducing a lower-priced subscription option that includes video ads in content. That hardly inspired confidence among analysts.

“While advertising is one potential way for Netflix to add another revenue stream, the initial allure of Netflix was that it didn’t have any ads,” said David Trainer, chief executive of Nashville-based investment research firm New Constructs. “It’s unclear if Netflix fans will be amenable to advertisements.”

Another way was to charge folks for piggybacking on the accounts of friends and family (we’ve all done it). This sounds like a good idea, but it may work better in theory than in practice.

​​”While management outlined plans to monetize the reportedly 100 million-plus nonpaying households that use Netflix by charging a “sharing fee,” we don’t believe that this strategy will be the panacea that some investors have outlined over the last few years,” noted Neil Macker, a senior equity analyst at Morningstar.

Some may pay the extra cost, but others will chafe against the price hike and cancel. Meanwhile, current freeloaders have already shown that they don’t value Netflix enough to pay for it on their own, so why would they suddenly start signing up en masse?

Netflix’s Competitors Are Multiplying

Netflix’s revenue growth also slowed in the first quarter. The company admitted that its runaway success during the Covid-19 lockdown led them to believe, mistakenly, that slowing growth was just a natural reversion to the mean.

As it turns out, intensifying competition may be the real threat to Netflix. Warren Buffett addressed an analogous situation when analyzing weakening media stocks in the early 1990s.

“Unfortunately, demand can’t expand in response to this new supply: 500 million American eyeballs and a 24-hour day are all that’s available,” wrote Buffett in a 1991 letter to shareholders.

Buffett was talking about newspapers and television—but he could have been talking about Netflix. With only so many hours a day to watch streaming video and an ever-expanding menu of options, the American consumer is already looking elsewhere.

Apple+ just won an Oscar for Best Picture for Coda, started streaming baseball games and is reportedly the front-runner to broadcast the widely popular NFL Sunday Ticket.

Amazon Prime Video is adding Thursday Night Football to its lineup, which brings in millions of eyeballs.

Disney+ and HBO Max release big-budget movies for paying audiences.

Toss in Hulu, Peacock and Paramount Plus, among others, and customers don’t lack streaming choices. But the whole point of cutting the cable cord was to lower costs, which means viewers will be discerning.

“Netflix was a pioneer in this space, but the party is over,” said Trainer.

Boring Is Back in Style

Netflix’s drop is reminiscent of Meta Platforms’ (FB) giant faceplant at the beginning of February, which resulted in the biggest one-day loss in share price in the company’s history.

The story was surprisingly similar: Meta’s profits came in below expectations, and executives lowered their forward guidance. Meta blamed Apple’s privacy policy change, users spending less time on money-making features and inflation.

They haven’t begun to recover. Meta’s stock is down roughly 30% over the past year, while the S&P 500 has gained more than 7% over the same period.

Netflix and Facebook aren’t alone. Amazon Inc. (AMZN) has dropped 6% over the past 12 months, while Twitter (TWTR) has fallen more than 30%.

Each of these formerly high-flying tech names stubbed their toe in their own way. The question for investors is what are the lessons to be learned.

One might be that market participants will have less tolerance for mistakes, given today’s economic realities. Higher interest rates put even more pressure on companies whose best years are in the past or the distant future. With inflation rising to 40-year highs, the Fed will raise interest rates throughout this year and into the next.

This dynamic has meant that demand has drifted away from companies that promise high growth and toward steady-eddy companies.

“There are periods when a speculative market focuses on hot stocks, but eventually something happens and prices start reflecting earnings,” said Jim Cullen, chief of Schafer Cullen Capital Management.

We may finally be at that moment. The Vanguard Russell 1000 Growth Index is down more than 12% this year. Meanwhile, the Vanguard Russell 1000 Value Index has basically stayed flat.

It’s easy to forget that just a year ago, with interest rates near all-time lows and direct payments hitting Americans’ bank accounts, investors were positively racing to embrace risk.

But the steep price that Netflix is paying for its earnings miss, following Facebook’s similar blood-letting, proves that those days are long gone.

For the time being, boring is back.

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