Shares of leading streaming player Netflix (NASDAQ: NFLX) is reeling from a sharp drop in prices, following the announcement of its 4Q21 results after the market closed on Thursday, January 20. The share prices closed 21.79% lower on Friday and dropped a further 1.89% in the pre-market trading session.
So far into the new year, the NFLX stock has declined 33.46%. After being one of the best performers among fellow S&P 500 companies in 2020, the share prices haven’t done too well in the past year either, recording a 28.61% decline.
Competition Affects Subscriber Growth
Investors have known for a while and Netflix was probably in denial all this time, but finally, management itself addressed the elephant in the room — the competition is getting too hot to handle.
“Consumers have always had many choices when it comes to their entertainment time – competition that has only intensified over the last 24 months as entertainment companies all around the world develop their own streaming offering. While this added competition may be affecting our marginal growth some, we continue to grow in every country and region in which these new streaming alternatives have launched,” noted management in a letter to shareholders on Thursday.
Despite releasing its largest volume yet of original content on a quarterly basis with 150 originals, the company missed its own expectations of subscriber growth, adding 8.28 million paid subscribers against a guidance of 8.5 million.
A tepid outlook for the first quarter of 2022 made things worse. Revenue growth for 1Q22 was guided to be 10%, after increasing 16% year-over-year in 4Q22. Needham analyst Laura Martin lost confidence in the stock, repudiating it as a growth stock henceforth.
Moreover, the guidance that the company provided for subscriber additions was also very discouraging. The company expects 2.5 million net paid subscriber additions, which looks quite meager as compared with the 4 million reported in the first quarter of 2021.
“In addition, while retention and engagement remain healthy, acquisition growth has not yet re-accelerated to pre-Covid levels. We think this may be due to several factors including the ongoing Covid overhang and macro-economic hardship in several parts of the world like LATAM,” explained management in the shareholder letter accompanying the earnings report.
However, the root of the issue may possibly lie in the fact that Netflix has become an increasingly expensive option within the streaming industry; and the ready availability of lower-priced providers has opened numerous options for cord cutters to choose from.
This brings us to another point of concern. Whatever subscriber growth Netflix is achieving is coming from lower ARPU (average revenue per user), particularly in countries like India where the company is discounting its price to drive subscriber growth. “We believe NFLX cannot work as a stock if it is losing its highest ARPU subs in UCAN (the United States and Canada),” reasoned Martin.
Decreasing ROIC is a Concern
Martin identified an important point here. She noted that the intense competition, which is threatening to steal its USP (unique selling proposition), will always keep Netflix from reducing its investment in content. So, this is going to be a perpetually increasing cost with no room for budgeting. Add video game expenses with no other revenue stream to the mix, and “falling ROIC (return on invested capital) for the foreseeable future” looks inevitable, thinks Martin.
Notably, ROIC measures how much a company is earning above its average cost towards debt and equity capital. “Since NFLX is giving subs more value by adding video games without charging extra, this implies limited pricing power to us,” noted the analyst.
What Could Make it Better for Netflix?
Recently, Netflix raised the prices in its $9-18/month tier. However, this may be detrimental to subscriber growth. Martin suggests a “second, lower-priced option to compete with Disney+, discovery+, Apple+, Hulu, Peacock, and Paramount+, each of which has $5-$7/month (or free) consumer options.”
Moreover, the company’s balance sheet is in such a position that it cannot afford to lose out on revenues. In such a scenario, a 5-6 minute/hour advertisement load for consumers as a second pricing option, simultaneously with the $5-$7/month consumer fee, is what Martin thinks can give an impetus to subscriber growth.
Shaken Confidence of Experts
Martin reiterated a Sell rating on Netflix. “We believe that because NFLX does not offer a separate, lower-priced, ad-driven tier, like almost all its streaming competitors, this lowers its ROICs, shrinks its TAM, grows its customer acquisition costs,” explained the analyst.
Wall Street analyst consensus is optimistic but is treading cautiously with Netflix, with a Moderate Buy rating based on 15 Buys, 15 Holds, and 3 Sells. The Netflix price target is $519.22 on average, implying an upside of 41.67%.
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