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Why Did Netflix, Inc. Shares Drop 19% in October?

By Daniel B. Kline - Nov 11, 2018 at 6:49PM

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The company released a strong earnings report.

Netflix (NFLX 5.03%) shares fell steadily in October, even though the company reported strong earnings and subscriber growth. It's hard to blame the drop on any specific metric, though shareholders may be concerned over the company's continued high levels of spending. Instead, it's more a general reaction to a company that faces increased competition.

What happened

The streaming giant saw revenue climb from $2.9 billion in the third quarter of 2017 to just under $4 billion in the same period this year. It also added roughly 6 million subscribers during the period. The only negative you can really take from the numbers is that penetration in the United States appears to be near its peak. Netflix added roughly 1 million paying U.S. customers in Q3 bringing its total to 58.46 million.

The Netflix home screen

Netflix has to spend billions on creating original content. Image source: Netflix.

So what

Netflix did see its free cash flow move in the wrong direction in Q3. CEO Reed Hastings explained what happened in his letter to shareholders.

Free cash flow in Q3 was -$859 million vs. -$465 million in the year-ago quarter. As a reminder, our growing mix of self-produced content, which requires us to fund content during the production phase prior to its release on Netflix, is the primary driver of our working capital needs that creates the gap between our positive net income and our free cash flow deficit.

Hastings also noted that free cash flow would be "closer to -$3 billion than to -$4 billion for the full year 2018." That's in line with the company's plans and forecasts, but that along with the looming shadow of Walt Disney's plans to enter the streaming space probably hurt the company's share price. After closing September at $374.13, shares fell to $301.78 to close October, a 19% drop, according to data from S&P Global Market Intelligence

Now what

Hastings isn't playing a short-term game. Netflix is spending heavily to build the biggest possible base of users around the world. Original content will cause cash flow deficits. At some point, however, the company will move from content growth mode to content maintenance mode, where it builds on its archive instead of having to build one. That may not happen over the next few years, but at some point, the need for new content will grow smaller.

Original content will also help fend off Disney. in reality, the Mouse House's new service will probably take market share from second-tier streaming services, and its existence may increase the audience for Netflix by encouraging more cord-cutting.

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