Netflix’s ‘Concerning’ Second Quarter: A ‘Minor Blip’ or a Warning Sign?

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“As the marketplace grows more crowded, and the quality of competitors improves, Netflix will have to work harder to attract subscribers,” analyst Jon Giegengack says

Netflix’s second-quarter performance wasn’t pretty. Nonetheless, Netflix still finds itself at the top of the streaming mountain, with more than 150 million global accounts. But Wall Street is more concerned with where a company is headed than where it currently stands. So where does that leave Netflix? Battered, but not buried, according to several industry experts. The streaming giant reported Wednesday the dreaded double whammy of acceptable, but not stellar, revenue growth, coupled with disappointing subscriber growth. Netflix added 2.7 million subscribers overall during the quarter — coming in 2.5 million customers shy of analyst expectations. Making matters worse, 126,000 U.S. subscribers dropped their service during the second quarter, a minor exodus that Netflix blamed on its recent price hikes. Netflix’s stock price — which is typically attached at the hip to its subscriber numbers each quarter — took a beating in the aftermath, with Netflix shares dropping more than 10% on Thursday morning. “It’s the first time in eight years they’ve lost U.S. subscribers, so psychologically that feels like an important thing,” Hub Entertainment Research analyst Jon Giegengack said. Giegengack said the the U.S. subscriber losses aren’t as damning as it seems, however, with the higher monthly fees driving an increase in average revenue per user. “What [Netflix’s second quarter] does tell us — if anyone still thought otherwise — is that as the marketplace grows more crowded, and the quality of competitors improves, Netflix will have to work harder to attract subscribers,” he added. Paul Hardart, a former Warner Bros. executive and current head of the Entertainment, Media and Technology Program at NYU, called Netflix’s results “concerning,” but pointed out “Q2 has historically been their worst quarter from a reporting standpoint.” Tom Harrington, senior research analyst with Ender Analysis, echoed Hardart, saying the quarter was “concerning,” as well, “given that Netflix’s path to sustainability requires charging more for the current product and/or spending less on content and tech.” This is where it gets tricky for Netflix. To boost revenue going forward, it needs to continue adding subscribers at a healthy clip. Raising prices again, after it just bumped up its fees, isn’t an option. And the company, in its letter to shareholders, shot down any notion it would launch an ad-supported tier — even if it’s worked out for competitors like Hulu. To grab more customers, Netflix will need to keep churning out shows people feel they have to see. With that in mind, the company’s second-quarter flop could be due to not only the price hikes, but simply a lack of compelling shows that came out during that time. Harrington acknowledged this possibility, saying results “could just be a minor blip,” and that “in all likelihood there will be growth in the current quarter, with big returning original shows like ‘Stranger Things,’ ‘Orange Is the New Black,’ ‘Money Heist’ and ‘Mindhunter’ — something that “usually results in a boost.” Still, Netflix has a major hurdle to clear in the next 18 months, with “The Office” and “Friends” — its two most popular shows, according to Nielsen — leaving for rival streaming services. This may spook some investors, and even drive some “Friends” diehards to eventually drop their service in favor of HBO Max, WarnerMedia’s upcoming service. But rather than looking at this as a gut punch, Netflix is framing it as an opportunity. The company, in its Wednesday letter to shareholders, said losing these shows will help with “freeing up budget for more original content.” (Netflix, it should be mentioned, has already earmarked $15 billion for content in 2019.) Hardart agreed, saying Netflix was poised to continue aggressively funding new shows. “My sense has always been that, though people may watch ‘Friends’ and ‘The Office’ on Netflix, they don’t get Netflix to watch those shows. They are great shows that are comforting in a crowded marketplace,” Hardart said. He continued: “Arguably, Netflix now has close to $1 billion dollars in fees they would have paid to license those shows to put towards new programming. Programming that could potentially be the ‘Friends’ and ‘The Office’ of tomorrow — as in ‘Space Force,’ the new Steve Carrell/Greg Daniels show they’re doing.” Finding those hits will only become more imperative for Netflix as Disney, Apple and WarnerMedia enter the market within the next year. Taking a step back, Netflix looks as formidable as ever. It just pulled in nearly $5 billion in quarterly revenue, setting a company record and increasing 9% quarter-over-quarter. It just earned 117 Emmy nominations, second only to HBO. And it holds a massive, perhaps insurmountable, lead over its competition when it comes to global subscribers. But to avoid a similar stock slide in the future, Netflix must return to adding subscribers at a healthy clip. Increasing subscription fees may have helped its top line, but the company’s share price is dependent upon customer acquisition. With more competition on the horizon, it’ll be tougher to wrangle new viewers — putting an even bigger premium on content than before. “The quarter is not a disaster,” Michael Queller, a Los Angeles-based securities trader said. “Netflix is not going anywhere. I’m not cancelling my account. Neither are you. The real concern is numerous streaming options are coming out in the next year, so is there any reason to think Netflix can grow significantly? I think it’s going to be a real challenge.”