Netflix (NFLX -2.12%) shares were getting banged up again after its third-quarter earnings report.
The streamer's quarterly results almost always prompt a big swing in the stock, and the latest example fits the pattern. Netflix shares fell as much as 7.1% on the news as the company missed its own guidance for subscriber growth, its most important metric. It added just 2.2 million new members in the quarter, worse than its dialed-down forecast of 2.5 million after subscribers surged by nearly 26 million in the first half of the year, boosted by lockdowns in the early months of the coronavirus pandemic.
While a pullback in the stock may be warranted after such a report, as it's now clear the pandemic-related tailwinds have passed, Netflix still looks well-positioned for long-term growth. In fact, there were a number of positive signs in the report, despite the slowing growth. Here are three reasons not to worry about slowing subscriber growth.
1. Netflix can do things its competitors can't
Management emphasized one word in its third-quarter shareholder letter, saying: "Our content successes highlight our ability to tap into our global audience of nearly 200 million members and underscore the notion that content is discovered on Netflix." Netflix subscribers regularly log in to find something new to watch, unsure of what's available. Other streamers simply don't have the volume of new content to accomplish this.
Disney+'s strength comes from the library of legacy content it has and the brand equity it's built with its customers over generations. HBO's comes from its reputation for high-quality programming and award-winning hits.
However, Netflix's ability to facilitate content discovery for both new programs and second-run ones is a unique strength, and in part a natural outcome of its massive audience. Management noted that shows like Schitt's Creek, Lucifer, and Cobra Kai had all found large audience on the platform. Cobra Kai had originally debuted on YouTube's subscription service, but the release of Season 1 on Netflix garnered views from 50 million member households in its first four weeks.
The company's huge audience makes it desirable for creators to work with, as most want to get as big an audience as they can. It also gives Netflix the ability to resurrect content, helping to pad its new releases, and keeping subscribers content. That sustains the flywheel effect whereby its demand from its subscriber base feeds creators, who in turn grow the subscriber base.
2. Existing customers aren't going anywhere
Netflix bears often argue that the recent wave of competition will permanently slow down growth and erode the company's competitive advantage. Though growth in North America did seem to slow briefly in the fourth quarter of 2019 in North America, when Disney+ was launched, and North American subscriber growth fell slightly in the second quarter last year after a significant price increase, there hasn't been much evidence that competition is siphoning customers away.
Despite the slow third-quarter growth, which was its lowest quarterly subscriber additions in years, management reassured investors that "retention remains well at very healthy trends, better than we were a year ago," as CFO Spence Neumann said on the earnings call. This indicates that Netflix seems to be winning the battle for time with its subscribers, which Co-CEO Reed Hastings thinks is the best metric to judge the company on.
That strong retention level also explains why Netflix recently decided to raise prices in Canada and Australia, two of its most mature markets. Many observers expect a price hike soon in the U.S. Netflix explained that it raises prices according to the value it provides to subscribers. COO Greg Peters explained:
"And if we do that well and we seek to basically every day be better about pretty much every component of how we're investing in that and make that efficiency and that effectiveness better, we will deliver more value to our members, and we'll occasionally go back and ask those members to pay a little bit more to keep that virtuous cycle of investment and value creation going."
3. The Asian market holds a lot of potential
Netflix's best performance in the quarter came in the Asia-Pacific region, where it added 1 million new subscribers, or 46% of its total growth in the period. Asia-Pacific is currently its smallest market, but has the most potential as the region, even without China, has more than 2 billion people.
Over the last year, Netflix's subscriber base in the region has grown by 62% to 23.5 million, while quarterly revenue has jumped 66% to $635 million. In the shareholder letter, Netflix also touted that it's now reached double-digit penetration rates in Japan and South Korea, two of the most important markets in the region, and it's making progress in other markets as well. In India, it launched a user interface in Hindi, and released the hit show Indian Matchmaking.
Asia has proven to be a tough market to crack for streamers like Netflix, but the high barriers of entry due to local regulations, language differences, and other reasons also give the company a first-mover advantage over other American competitors as it builds out its subscriber base. Netflix is experimenting with a mobile-first strategy, offering mobile-only plans in a number of Asian countries as content is often consumed primarily on smartphones. Additionally, it plans to offer a free weekend of Netflix for everyone in India as a marketing technique, a strategy it may try in other countries as well.
Add it all up, and Netflix's fundamentals are strong
Finally, Netflix's user growth may have disappointed, but the business's profitability has never been stronger. Operating income rose 34% to $1.3 billion, and the company now expects to generate positive free cash flow of $2 billion for the year due to the production effects of the pandemic, helping to put to rest concerns about its debt burden.
While growth may be sluggish through the first half of next year, Netflix is still in the driver's seat in the fast-growing streaming industry . A modest subscriber growth miss shouldn't dissuade investors of its potential.