Netflix Has a Problem That Is Bigger Than the Numbers

Netflix (NASDAQ:NFLX) delivered a better-than-expected (or maybe simply better-than-feared) earnings report. The streaming giant posted larger than expected earnings per share (EPS). And the $5.47 billion in revenue that Netflix posted was slightly over the consensus estimate. But more significantly, the company’s revenue was up over 30% on a year-over-year basis.

But the numbers that had everyone’s attention were the subscriber numbers. Specifically, how many new subscribers is Netflix adding? And how many subscribers is the company losing?

In the first quarter of 2019, Netflix reported a record 9.6 million net new subscribers. One year later, the company is projecting about 7 million net new subscribers. The 28% decline may be the first evidence of the effects of the increased competition that is saturating the marketplace.

However, one comment from the company’s earnings call that drew my attention was when Netflix CFO Spencer Neumann acknowledged that the company saw “elevated churn” (i.e. more people canceling the service). And while Neumann pointed out that some of these subscribers only leave for a short period of time. It does point to the larger issue of whether the company can retain its current subscribers.

And that’s where things get as precarious as, well, a house of cards, for Netflix.

Password sharing puts a value on the Netflix service

In 2017, a study found that 92% of college students had a Netflix account. However, only about a third of those respondents actually paid for Netflix. This is because Netflix has always had a laissez-faire attitude about password sharing. The belief is that what a customer chooses to do with their password is their business. The only restriction that Netflix makes is to limit the number of devices that can be streaming the service at one time.

I have two college students who use the family account while they’re away at school. I also have had a friend (or two) ask if they could use my Netflix password to access the service. It’s not illegal, and in some cases it simply is more convenient in a short-term situation.

However, if there’s one thing that marketing teaches you it’s that free has a value. Ultimately every user that is sharing a password is a prospective paying customer. And therein lies the problem. What happens when these users have watched everything they want to watch, for free? Will they agree to pay for the service?  

This is a question of the glass being half empty or half full. Netflix will reference a survey conducted in 2017 that showed nearly half of the respondents that engaged in password sharing would pay for their own subscription if they could not share the account.

Of course that also means that more than half would not. But keep in mind, the survey is now nearly three years old. Netflix lives in a very different world.

It’s Not Just the Competition. It’s the Content

I happen to enjoy some of the original content on Netflix. But Netflix has always known that original content is expensive to produce. And it’s not getting any less expensive. And Netflix continues to burn through cash. But to what end?

Many of the heaviest users use Netflix for its licensed content. But Netflix has already lost some of its licensed content and it will be losing more as entertainment companies such as Disney (NYSE:DIS) and NBC, bring their content back in house. The company is slated to lose The Office at the end of 2020. If social media is any indicator, I imagine a lot of users will be following that program to whatever streaming service it migrates to. But once it’s off Netflix, will the company still be a compelling option.

Netflix Has No Room Left to Grow

Central to the bearish case against Netflix is that the stock simply grew too fast. The current share price even though it is significantly below its record level of 2018 is priced to reflect the company that Netflix used to be. Or maybe a better way to say it is it reflects a competitive landscape that has changed significantly.

But Netflix maintains a price, and expectations, of a growth stock. That may not be a fair assessment of the stock anymore. In fact, I can see a scenario in which Netflix may become a takeover target. That notion may seem crazy given the fact that Netflix has an enterprise value of $140 billion. Realistically, But that only narrows the field. The reality is that Netflix can be a very attractive addition to a number of companies.

And according to Needham analyst Laura Martin, Netflix could have suitors. Specifically, Martin cites Comcast (NASDAQ:CMCSK, Apple (NASDAQ:AAPL) and AT&T (NYSE:T) as companies that have logical synergies with Netflix.