Shares of streaming giant Netflix (NFLX 2.32%) have taken a beating recently, falling more than 37% in January alone. The fall was spurred by the release of Q4 results for 2021, which ended Dec. 31. It doesn't help that the broader market's been unkind to growth stocks lately, on top of the face that the company's earnings disappointed investors, sending the stock lower.
The company has been such a dominant market player that investors have to be questioning whether this recent speed bump is a sign of trouble, or an opportunity to acquire a great stock at a discount. It's hard to see far into the future, but investors should consider some cautionary signs before they make a decision.
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Membership growth is struggling to drive revenue
Netflix drives revenue growth in two ways: It can either grow its subscriber base or raise its subscription prices. Getting more subscribers is ideal because you don't have to worry about driving away your existing customers by charging more. Subscriber growth has been arguably the most crucial metric investors look at as a result.
Netflix's global paid subscriber count has grown as follows, shown below at the end of the fourth quarter for the past several fiscal years:
| Quarter | Subscribers | Growth (YOY) |
|---|---|---|
| Q4 2017 | 110.64 million | 24.2% |
| Q4 2018 | 139.26 million | 25.9% |
| Q4 2019 | 167.09 million | 20% |
| Q4 2020 | 203.66 million | 21.9% |
| Q4 2021 | 221.84 million | 8.9% |
Source: Netflix quarterly filings. YOY = year-over-year
There was an obvious slowdown in subscriber growth in 2021, which could be due to a combination of people wanting to get out more following the lockdowns in 2020, plus a more competitive environment than in previous years. Netflix is facing competition from both streaming services and gaming, which is especially popular with younger users. A study by Limelight estimated that 51% of gamers worldwide would rather play games than watch TV, and only 33% of users aged 18 to 35 preferred streaming content.
If subscriber growth stays down, it will pressure Netflix to raise its prices to generate revenue growth. The company's standard plan has increased from $7.99 per month in 2011 to $15.49 per month in 2022. But with more competition in recent years from services like Walt Disney's Hulu and Disney+, raising prices on a regular basis is not a great long-term growth strategy. Netflix's standard plan is already among the most expensive offerings compared to HBO Max ($15), Disney+ ($8), and Hulu ($13 for no ads), so it's fair to question for how much longer Netflix can get away with increasing prices.
Content costs remain high
Netflix spends a lot of money on creating and licensing content, so it's important to understand how its financials work. It spends money upfront to create content, and then Netflix recognizes its value over time, which adds back into its bottom line. It's like spending money on ingredients for pizza but not enjoying the results until after the pizza's been cooked and eaten.
NFLX Revenue (TTM) data by YCharts
The accounting behind this makes it look like Netflix is really profitable: It reported $607 million in net income for 2021 Q4. However, if you look at free cash flow (FCF), Netflix isn't generating enough cash to fully fund its content. Its free cash flow in Q4 was negative $569 million, and free cash flow has been negative in four of the past five quarters.
Netflix spends a lot of money to create and license content, so even though it's a technology company that just finished the year with $30 billion in revenue, it doesn't have any cash left after investing in its business.
Investors would ideally like to see the company's free cash flow increase as revenue growth outruns the costs of content and growing the company, but it hasn't happened. I believe this is a major potential problem if revenue growth doesn't pick back up.
Can Netflix find new revenue streams?
Netflix doesn't have to rely on its traditional business to continue growing over the years to come, and investors will need to decide how much they think the company can innovate to bring on new income streams. It is currently entrenched as the world's leading streaming platform, so it can leverage its massive 221 million user base to create new revenue streams.
Netflix is already getting into gaming, launching a mobile gaming service for mobile devices in November 2021. It has only released a handful of games, based on the platform's hit content like Stranger Things, and is still free for all its customers. This is still an experiment, but the company would likely increase its investment in gaming if this succeeds and could eventually monetize the effort with a subscription plan.
The easiest path to sustained growth might be for Netflix to begin showing ads. The possibility of this is more speculation, and the company has historically relied on subscription fees to provide an ad-free experience, but companies like Roku are showing that ad-supported content can still work for committed viewers.
Lastly, Netflix could eventually grow its intellectual property enough that it can take advantage of more licensing opportunities for things like merchandise. This is something that Disney has mastered, but it has a multi-decade head start doing it.
The bottom line
There's no such thing as smooth sailing on the stock market. There are bound to be rough spots, and Netflix has hit one after its disappointing quarter. Investors will need to decide whether they believe Netflix can innovate and bring new revenue streams to its business, or if its inability to generate free cash flow will be a long-term headache that makes the stock unworthy of owning.
