Investors have pressed pause on Netflix (NFLX 4.28%) shares, which are down a whopping 69% in 2022. Negative sentiment surrounding the business, especially in light of a loss of 200,000 subscribers in the first quarter and the expectation of losing 2 million more in the current quarter, has hardly been higher in recent memory.
For a business that has thrived for most of the past decade, shareholders are now starting to worry that the days of fast growth might be coming to an end for this popular streaming stock. For what it's worth, I do believe that Netflix still has a massive opportunity in front of it. It just won't be as easy as it has been, adding to the uncertainty.
Let's take a closer look to see if Netflix's growth is really over.
The U.S. and Canada appear saturated
During the first three months of 2022, Netflix lost 640,000 members in the UCAN (U.S. and Canada) region. With each passing quarter, it's starting to look more and more like this market has reached a plateau in terms of net customer additions.
As of March 31, Netflix counted 74.6 million memberships in UCAN, with another 30 million households that management believes are sharing passwords. Combined, these 105 million households are close to the 116 million cable-TV households in the two countries at that industry's peak in 2010.
Even more alarming is the higher-than-expected churn that Netflix saw in Q1 in the UCAN region. This trend supports the argument that the company's pricing power, a key part of its investment thesis, might actually be weakening.
On the plus side, however, the company's announced plan to offer a cheaper, ad-supported subscription tier should help to attract price-sensitive customers. And at the same time, it could convert password-sharing accounts to paying households.
International markets will drive growth
While growth might stall in Netflix's two most mature countries, the U.S. and Canada, expansion in foreign markets will be a big business driver as we look ahead. In the Asia-Pacific (APAC) region, Netflix currently has 33.7 million subscriptions and generated 11.7% of its $7.9 billion in overall revenue during Q1. Not only is APAC Netflix's least penetrated market, but it was the only region that registered membership growth last quarter.
Image source: Getty Images.
In India, a country that is expected to have 653 million internet users this year, Netflix is aggressively trying to add customers. The company recently lowered pricing there in order to better compete with Amazon Prime Video and Walt Disney's Hotstar. Growth can certainly come from lower-income countries, where Netflix offers mobile-only plans, but the revenue opportunity will definitely be limited compared to the more affluent UCAN, for example.
There are about 750 million broadband subscriptions (and growing) in the world right now (excluding China, where Netflix isn't available). Assuming the business can reach the level of penetration it has in UCAN in other markets across the world, it's easy to see Netflix's current membership base of 221.6 million rising substantially.
It won't be easy
To be clear, none of this will be easy. For most of the past decade, Netflix was the best and only streaming option available. This lack of competition meant that the business was attracting customers by simply being a better user experience than traditional cable TV. However, now that viewers have an endless number of choices at their fingertips, Netflix needs to find other ways to differentiate itself.
This means continuing to spend heavily on content in order to produce the best movies, documentaries, and shows. In an era of loose monetary policy, low interest rates, and low inflation, that wasn't a difficult task. But in today's economic environment, it can get expensive for Netflix to bid on and work with the top producers and writers, especially with other deep-pocketed rivals aiming for the same talent and content deals.
Consequently, Netflix's operating margin, which has increased by three percentage points annually in recent years, will remain flat at roughly 19% to 20% in 2022 and 2023. And although the company's long-awaited ambition to generate positive free cash flow is still on the table starting this year, it won't really please shareholders if membership numbers aren't rising.
Reed Hastings and his team have historically proven their tremendous ability to change course and pivot when times get difficult to drive higher growth levels. Therefore, it's hard to bet against this management team. Even so, I think there's a better way for investors to play the ongoing secular trend of streaming entertainment.
