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Netflix’s Q4 2019 U.S. Subscriber ‘Miss’: The Storm After The Calm?


steven36

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All media, entertainment and tech eyes focused yesterday on Netflix’s Q4 2019 earnings report, hoping to learn how Netflix would fare in its first few months of direct U.S. competition by new mega-streaming entrants Disney+ and Apple TV+ (both of which launched in early November). The short answer? A mixed bag. The company beat the Street’s revenue expectations (earnings per share came in at $1.30 rather then the expected $.53), and also far exceeded forecast international subscriber growth numbers (8.33 million net subscriber additions versus the forecasted 7 million). The company closed out 2019 with 167.1 million subscribers (61 million of whom are in the U.S.).

 

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But the big story - sure to have Hollywood and Wall Street water coolers buzzing - is that Netflix also missed big on its U.S. domestic subscriber growth numbers (420,000 net subscriber additions versus the forecast 600,000). That’s three straight quarters of U.S. subscriber “misses.” Importantly, Netflix, in its quarterly shareholder letter, chalked up Q4’s “miss” to “probably [being] due to our recent price changes and to U.S. competitive launches.” CEO Reed Hastings more pointedly conceded that Disney+ “takes a little bit away from us” in Netflix’s posted Q4 2019 earnings interview led by Guggenheim analyst Michael Morris.

 

That is significant. First, Netflix itself concedes that the much-heralded streaming wars likely are directly and adversely impacting its own business. Second, Disney+ only directly competed with Netflix for about 50% of Q4 2019 (it launched across the U.S. on November 12 and, as I previously reported in Forbes, is reported to be an early breakout success; Apple TV+, not so much). Third, Disney+ only launched in a small handful of international markets (four, compared to Netflix’s 200+), so its immediate international impact is naturally less meaningful so far. Disney is now accelerating its European rollout to capitalize on its early success. Fourth, Netflix also saw increased “churn” in Q4 (something to be watched closely in the coming quarters as the streaming wars mature). Fifth, international subscribers likely generate less revenue - and cost more to acquire and retain - than U.S. subs. That’s a problem, because Netflix increasingly banks on international growth in a saturated U.S. market.

 

Sixth, Netflix’s own statement about potential adverse impacts of “recent price changes” do not bode well for the prospects of Netflix being able to raise prices in the future to drive revenue growth, although both chief content officer Ted Sarandos and chief product officer Greg Peters strongly signaled that future price hikes are likely. In Sarandos’ words in yesterday’s post market close earnings interview, “If we’re putting hits on the board ... then the more frequently we can go back [to our users].” Those upward pricing ticks certainly did the trick to boost revenues in the past.

 

But those tricks may be significantly more difficult to pull off in a world where Disney+ and the other new streaming goliaths hold unique power to undercut Netflix pricing at every turn due to their significantly more flexible business models. Remember, Disney+ launched at $6.99 per month and Apple TV+ at $4.99 per month (free to buyers of Apple hardware). Netflix drives only one revenue stream (and continues to insist that it will not add advertising). The others do not. They boast several. And their streaming services can serve as loss leaders as a result (I have written about this several times for Forbes, including this analysis which delves into this point more deeply). That’s predatory pricing 101. And, according to a recent survey by PC Magazine, pricing still matters most to streaming consumers.

 

On the issue of content, in the earnings interview, CFO Spence Neumann confirmed that Netflix spent over $15 billion in 2019 and plans to increase its content spend this year (a $17+ billion number has been widely reported). Neumann further underscored that over 50% of Netflix’s cash spend is now on its exclusive originals. In his words, “We are scaling into the business. The future of this business is originals.” In particular, Netflix plans to significantly expand its large scale feature films and animated films for 2020. As for the early impact of Friends leaving Netflix at the end of 2019, Sarandos answered that there has been “nothing that we’ve seen or can measure.” He dismissed such concerns and insisted that “Our customers will find their next favorite show.”

 

Analyst Michael Morris ended the earnings interview by asking each participating Netflix exec what is most misunderstood about the company. Perhaps CFO Neumann gave the most interesting answer. “What’s most misunderstood is the business model, and what you see in our cash flow generally and folks thinking we are losing money, if you will, when we’ve shown that we’re increasing our profitability.” True enough. Netflix is profitable. At the same time, however, Neumann continued that Netflix is growing “a very profitable business which will over the years become self-funding.” So profitable, yes. Cash flow positive, no. And, that is the question. When will that time come when Netflix is self-sustaining? Certainly not anytime soon, as Netflix’s debt burden continues to balloon and now exceeds $15 billion. Accelerating content spends don’t ease that pressure.

 

Nor does its increasingly hyper-competitive landscape that will continue to expand, as both NBCUniversal’s Peacock and AT&T’s HBO Max join these turbulent waters (the former in April, the latter in May). And while today’s streaming wars may not be a zero sum game, make no mistake that executives in the trenches of all major streamers feel the heat of battle. After all, consumers do have limits to what they are willing to pay for their entertainment options (I previously analyzed this for Forbes and reported that three is the magic number for video streaming services). It only stands to reason that more monthly subscription choice, means more potential impact on Netflix (and all others).

 

Prior to Disney+’s and Apple TV+’s entry into the premium streaming subscription market, Netflix experienced smooth sailing for the most part. Yes, it faced competition from Amazon Prime Video, Hulu and others in the domestic marketplace. But that is a far cry from 2020’s new realities. Could a storm be brewing?

 

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