Netflix (NFLX 0.33%) stock just had its worst trading day in nearly 20 years. The streaming stock plunged more than 30% Wednesday after the company reported a surprise decline in its subscriber base in the first quarter, and forecast a decrease of 2 million subscribers in the second quarter.
Netflix lost 200,000 subscribers in Q1, compared to guidance calling for 2.5 million additions. Excluding its exit from Russia, the company added 500,000 subscribers in the quarter, but even Netflix's own management seemed surprised by the disappointing results.
In its letter to shareholders, management acknowledged that "revenue growth has slowed considerably" and also said it has work to do to reaccelerate subscriber demand and revenue.
Management put the brakes on its goal of improving operating margin by three percentage points every year and said instead that it would hold its operating margin at 20% for at least the next year or two until revenue growth started improving again.
The company identified four reasons for the sudden slowdown in subscriber growth:
- The pace of growth in the underlying market is due to some factors out of its control, like the adoption of smart TVs, which may have slowed in the later stages of the pandemic.
- The company estimates that on top of its 222 million paying subscriber households, 100 million households are using the service without paying for it due to password-sharing.
- Competition in the industry is intensifying as several other media companies have launched streaming services in the last few years.
- Finally, macro issues like the war in Ukraine, inflation, slowing economic growth, and COVID-19-related disruptions are having at least a marginal effect on the company's performance.
Of those four issues, what's changed the most in the streaming landscape recently is the degree of competition, especially in North America where Netflix has struggled to grow its subscriber base and lost 640,000 paying households in the most recent quarter.
In the last three years, competitors like Disney+, ESPN+, Apple TV+, Comcast's Peacock, HBOMax and Discovery+ from Warner Bros. Discovery, and ViacomCBS' Paramount+ have all launched. In other words, streaming is no longer challenging linear TV. It's gone mainstream, and cord-cutters have a buffet of options to choose from if they don't find Netflix compelling.
About that competitive advantage
For years, Netflix's competitive advantage was clear. As a stand-alone streaming company, it could invest all its resources into internet TV, while peers like Disney were hesitant to disrupt their lucrative cable businesses. However, legacy media companies have now fully embraced the streaming future, and Netflix is no longer unique as a streaming-first company. Disney, whose Disney+ streaming service has amassed more than 100 million subscribers globally less than three years after its launch, even restructured its business to make streaming the focus of its video entertainment division.
For a long time, Netflix's unique position in streaming helped drive its growth. As cord-cutting proliferated and Netflix's content slate improved, it continued to build subscribers. Now, Netflix is fighting a different war. Though management brought up linear TV multiple times in the shareholder letter and on the earnings call, it's not enough anymore for the company to be better than cable. Netflix has to be at least as good as -- if not better than -- the streaming alternatives, and there are signs it's failing in at least some of those areas.
For instance, after years of striving to become the first streaming service to win the Oscar for Best Picture, Netflix was bested by Apple, which grabbed it with CODA this year. Though management often likes to discuss its Oscar and Emmy wins and nominations, it made no mention of the award shows in this most recent letter.
Netflix's showing in the top categories at the Emmys, Best Comedy and Best Drama, has also been rather weak. It only won one of those awards for the first time last year, with The Crown taking Best Drama. In contrast, Amazon has won Best Comedy for two separate series, Apple and Hulu have each won one of those awards once, and HBO has won one of them in six out of the last seven years.
In other words, when it comes to trophy hardware, Netflix has relatively little to show for its massive content budget.
One reason to be hopeful
While competition has eroded Netflix's competitive advantage, there are still some key ways that it does have an edge. The company's massive global audience makes it the most attractive streaming partner for creators, who want to get their content in front of as many eyes as possible.
Netflix is also much more global than any of its competitors. Its ability to pick shows like Squid Game or La Casa de Papel (aka Money Heist) and make them hits around the world is unique and gives it an edge in finding stories in international markets. Co-CEO Ted Sarandos said as much on the call: "Our ability to do that and to bring kind of global notoriety to local content players is unprecedented and it's pretty unrivaled at this point."
It's tough for Netflix investors to see the stock fall off a cliff like this, trading lower than it's been since early 2018, but there's a silver lining here. The stock is now incredibly cheap, trading at a price-to-earnings of just 20, or cheaper than the S&P 500.
Management said it expected to return to subscriber growth in the second half of the year, and it's confident in its ability to extract value from the 100 million households that are taking advantage of password sharing. Co-CEO Reed Hastings even said Netflix would offer a lower-tier advertising option in the next year or two, tapping into a monetization opportunity that many investors have long asked for.
Netflix faces clear challenges, but management has plans to reignite growth. Despite the stock's woes, it would be a mistake to bet against this management team, as the stock is still one of the best-performing of the 21st century.