Netflix's (NFLX +1.50%) stock recently sank to its lowest levels since early 2018, following its first-quarter earnings report on April 19. The main reason was its first loss of subscribers in more than a decade.
Netflix ended the first quarter with 221.64 million subscribers, which represented a sequential decline of 200,000 subscribers. It mainly blamed that loss on the suspension of its services in Russia. Excluding Russia, its subscribers would have risen about 500,000 sequentially.
However, Netflix also predicted its subscribers would drop by another two million sequentially in the second quarter -- which suggests that Russia isn't its only problem. During the conference call, co-CEO Ted Sarandos admitted the company was facing "heightened levels of competition."
Image source: Getty Images.
That bleak outlook, along with the need to ramp up its spending to break out of its rut, drove the bulls away. But if we dig deeper, we'll spot four additional red flags indicating Netflix's high-growth days are over.
1. Its abrupt U-turn on ads
In the past, Netflix scoffed at the idea of adding an ad-supported tier. In a shareholder letter from the second quarter of 2019, it said it would "have a more valuable business in the long term by staying out of competing for ad revenue and instead entirely focusing on competing for viewer satisfaction."
During the conference call in the fourth quarter of that same year, co-CEO Reed Hastings (who was the only CEO until 2020) said Netflix would be "strategically disadvantaged" in online advertising because it didn't have access to as much data as larger tech companies like Alphabet's Google. Hastings also said Netflix wanted to operate a "simpler business model" and avoid all the "controversy around exploiting users with advertising."
But over the past two years, Comcast's (CMCSA 1.68%) Peacock and the Roku Channel both gained more viewers with their free, ad-supported platforms. Disney and WBD's (WBD 0.22%) HBO Max also recently rolled out cheaper ad-supported tiers.
All that pressure seems to have finally forced Netflix to change its tune. During the first-quarter conference call, Hastings said Netflix was considering the launch of a cheaper ad-supported tier for "ad-tolerant" viewers. That abrupt shift might widen its moat, but it also strongly suggests Netflix is starved for new subscribers.
2. Chasing shared passwords
In addition to Russia and competitive headwinds, Netflix blamed its recent slowdown on its passwords being shared to an additional 100 million households worldwide. It previously turned a blind eye to that issue, but it now plans to charge its subscribers extra fees to share their passwords.
Netflix didn't reveal exactly how much it would charge for shared passwords or how it would actually enforce the rules, but that sudden change could alienate a lot of its subscribers and drive them to rival platforms. That's another bright-red flag that indicates it's desperate for growth.
NASDAQ: NFLX
Key Data Points
3. AT&T's latest earnings report
AT&T (T 0.36%) recently posted its first quarterly report as a stand-alone company following its spin-off of WBD on April 8. That also marked the last time WarnerMedia's results would appear alongside its telecom business.
AT&T ended the first quarter with nearly 77 million HBO and HBO Max subscribers worldwide -- an increase of almost 13 million subscribers year over year and three million subscribers sequentially.
HBO's results aren't exactly comparable to Netflix's since the former includes both its linear TV and streaming video subscribers. However, it certainly seems like HBO is growing as Netflix shrinks.
Additionally, HBO's recent combination with Discovery+ under the WBD umbrella -- which will reach nearly 100 million subscribers worldwide -- could generate even tougher competitive headwinds for Netflix this year.
4. Bill Ackman's massive loss
Back in January, Pershing Square's Bill Ackman took a $1.1 billion stake in Netflix after its post-earnings plunge. At the time, Ackman said Netflix's subscription-based revenues still had "enormous future growth potential" and that it had plenty of "pricing power" to boost its margins.
But shortly after Netflix's first-quarter report, Ackman sold his entire stake for a loss of more than $400 million. In a letter to Pershing Square's investors, he said the firm had "lost confidence" in its "ability to predict the company's future prospects with a sufficient degree of certainty."
Ackman attributed that change of heart to Netflix's "disappointing" subscriber growth, its decision to be "more aggressive" in chasing non-paying customers, and its planned integration of ads. Ackman's hasty retreat indicates it could take a long time for Netflix's stock to recover.
Stay away from Netflix for now
Value-seeking investors might think Netflix looks historically cheap at 20 times this year's earnings. However, that price-to-earnings ratio is still tethered to analysts' older estimates -- which might come down significantly as its growth decelerates over the next few quarters.
Many traditional media stocks -- including WBD, Comcast, and Paramount -- are also still trading at much lower multiples. If the market starts to value Netflix like a media company instead of a tech company, its stock could be cut in half again. Simply put, investors should avoid this fallen FAANG stock and stick with more reliable plays in this challenging market.
