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Netflix Beat Subscriber Expectations by Returning to Normal

By Adam Levy - Jan 22, 2021 at 8:30AM

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Netflix's fourth quarter looked a lot like previous fourth quarters.

Around the world, 8.5 million households signed up for a new Netflix (NFLX 5.03%) account in the last three months of 2020. That far exceeded Wall Street analysts' expectations and the company's own guidance for the quarter. Management said investors should expect just 6 million subscriber additions as it continued to adjust to the pull-forward of subscribers early in 2020.

But 8.5 million net subscriber additions is roughly in line with the number of subscribers Netflix added in the fourth quarters of both 2018 and 2019. In other words, the company returned to normal after a few volatile quarters. And that bodes well for what's ahead.

A reception desk with Netflix logo above it.

Netflix offices in Singapore. Image source: Netflix.

Is the hangover cured?

Netflix experienced a bit of a hangover after millions of new customers signed up for the streaming service in the early months of the coronavirus pandemic. Net additions fell from 6.77 million in the third quarter of 2019 to 2.2 million during the same period in 2020. Management told investors to expect the pullback in subscriber growth, but the 2.5 million management forecast for the third quarter was still too optimistic.

The return to historic growth levels in the fourth quarter indicates Netflix may have already moved past the pull-forward effect of pandemic-fueled subscription growth by the end of the third quarter.

The Europe, Middle East, and Africa region and the Asia-Pacific region both grew in line with last year's numbers. Latin America grew a bit more slowly than last year, and the U.S. and Canada grew faster. The latter is particularly notable after Netflix raised prices in Canada and the U.S. in the middle of the quarter.

Management's guidance calls for 6 million net subscriber additions in the first quarter. While that's slower than in 2018 and 2019, it's roughly in line with 2017 net additions.

During the earnings call following the release, CFO Spencer Neumann was asked why he guided for first-quarter net additions lower than the fourth quarter, despite it typically being a quarter for sequential growth. He was hesitant to say the impact of early 2020 was behind Netflix. "There's probably still a little bit of that pull-forward dynamic in the early parts of 2021," he said. "It's more uncertain than we've ever seen, and we're trying to forecast through that," he added.

But while there may be some near-term uncertainty, Neumann said "the long-term growth trajectory is at least as strong as ever."

Why a return to normal is great news for investors

Even if the impact of the pull-forward in early 2020 still pops up in Netflix's first-half results this year, the full-year results should look a lot like previous years. And that means continued subscriber and revenue growth.

The better-than-expected fourth quarter net additions will have a profound impact on Netflix's operating margin and cash flow. Since Netflix already has its content investments planned for the year, incremental subscription revenue flows primarily to Netflix's bottom line. Since Netflix outperformed its expectations by 2.5 million last quarter, that represents about $330 million in additional annual subscription revenue Netflix will bring in during 2021 that it wasn't anticipating at the start of the fourth quarter, based on its average revenue per user of $11 per month.

A faster return to normal in the first half of the year than initially anticipated means still more full-year 2021 revenue. As a result, management increased its free cash flow guidance to breakeven, instead of a range from negative $1 billion to breakeven.

Management also believes it will no longer need to raise debt to fund day-to-day operations, and it could return excess cash to shareholders through a share buyback.

Long-term investors have always seen the potential for Netflix to produce strong free cash flow as subscriber growth caught back up to its content investments. The shorter-than-expected subscriber growth hangover from the first half of 2020 will get Netflix to that point sooner than anticipated. That's what has investors in the media stock sending shares higher following the company's fourth-quarter report. 

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