Netflix (NASDAQ:NFLX) stock got hammered earlier this week after reporting first-quarter earnings. The problem wasn't its results, but its forecast for the current quarter. Netflix added a record 6.74 million total subscribers in the first quarter, but expects that clip to fall to just 2.5 million in the second quarter, a sharp drop from the barely profitable company that's still viewed as a growth story.
Domestically, Netflix sees its subscriber adds slowing from 2.23 million to just 500,000, but that sort of shift is normal due to seasonality as fewer Americans join the service during the warmer months. Internationally, it was a different story. After posting a record 4.51 million sign-ups abroad last quarter, Netflix expects that number to fall by more than half to 2 million, its lowest international growth rate since 2014. First-quarter additions were juiced by Netflix's entry into 130 countries simultaneously in January, but now that its international expansion has been completed, adding new subscribers may become more difficult.
Management explained that it expects fewer international subscribers in the current quarter than a year ago due to a tough comparison with its launch in Australia and New Zealand last year. That seems like an odd excuse since Australia/New Zealand is a small market with just about 10 million broadband-connected households -- and because the company has no more new launches to drive subscriber growth, it could be a sign that its fastest growth may be behind it.
Is the second-quarter projection the new normal for Netflix?
Domestic growth as the model
It's reasonable for investors to be discouraged by the Q2 forecast as it calls for the slowest total growth in two years, but there's one excellent indicator of Netflix's ability to deliver consistent growth: the U.S. segment.
Netflix launched its DVD-by-mail service in the U.S. in the 1990s, started offering streaming in 2007, and separated the two services in 2011. It's been a well-known brand at home for over a decade, yet its growth over the past few years has not featured any sort of the decline you might expect from a maturing market.
As the chart above shows, Netflix's domestic subscriber adds have ranged between 5.4 million and 6.3 million in the four years since the streaming service was separated. There's a good reason why subscriber growth has remained consistent even as Netflix penetrates the U.S. market further: its content has improved substantially, and it's set to offer 30 original series this year, more than any other broadcast or digital competitor, along with 600 hours of original programming. Technology has also improved through the proliferation of smart TVs and other such devices that make streaming even easier, convincing Americans to drop cable and sign up with Netflix.
The international market is murkier than the domestic one, but Netflix's growth abroad could play out in a similar fashion.
On the recent earnings call, CEO Reed Hastings stressed that Netflix is still rather primitive in many of the countries in which it just launched, as it's only available in English and payment is only accepted with international credit cards. As it adds content in local languages and new payment options, the subscriber base should increase. The company is making significant efforts to add such programming, with the release of the French-language Marseilles, and Narcos, which was mostly in Spanish, and promised more local-language programming to come.
It seems likely, then, that last quarter's 6.7 million subscriber additions will mark a peak for Netflix for the foreseeable future -- but that doesn't mean the growth story is over. Netflix is playing the long game here.
Hastings has repeatedly stressed that he sees the transition from Linear TV to Internet TV as a gradual one, with eyeballs shifting incrementally over the next 20 years. On the call he predicted, "In the long term, everybody around the world is going to be watching Internet video. And we want to be well positioned so as all of these countries evolve toward Internet video that we grow with them. In some cases that will be 10 years, 15 years, in other cases it will be in the next 2 or 3 years. But it's a long-term investment, and country by country it's worked out extremely well for us."
The proliferation of broadband technology in the developing world over the coming years should ensure that Netflix grows gradually abroad, as Hastings argues. Over the next few years, then, a reasonable expectation for Netflix's subscriber growth may be 5 million new members domestically and 10 million internationally a year, slightly lower than the rate last year.
Investors nervous about next quarter's projection need to remind themselves of the long-term opportunity. Netflix is positioning itself to be the dominant global video entertainment provider, a huge potential market. It won't happen overnight, but with the company's growing catalog of original programming and its presence around the world minus China, it's taking all the right steps. With patience, the subscriber numbers will continue to grow and profits will follow.
Jeremy Bowman owns shares of Netflix. The Motley Fool owns shares of and recommends Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.