Netflix shares: is the growth story over?

The story of Netflix (NASDAQ: NFLX) shares would make for a compelling original series. Found in 1997 renting DVDs by post, by 2007 it discovered a monopolistic niche in streaming across the internet.

Netflix’s share price exploded from under $10 in 2012 to a record $692 by 17 November last year. But the euphoria has not lasted.

Netflix share price: Q1 2022 results

Q1 results were not quite an unmitigated disaster for Netflix. But they came close, as Netflix shares plunged by 35%, shaving $54 billion off its market cap.

However, revenue increased by 9.8% year-over-year and 2.1% quarter-over-quarter to $7.868 billion. And it maintained a healthy 25.1% operating margin.

Moreover, net cash generated by operating activities was $923 million, compared to $777 million in Q1 2021, while free cash flow rose to $802 million from $692 million. And Netflix expects ‘to be free cash flow positive for the full year 2022 and beyond.’

But the streamer has gross debt of $14.6 billion, at the top end of its target range of $10-15 billion. And with cash of only $6 billion, net debt stands at a significant $8.6 billion.

And most worryingly, it lost 200,000 subscribers in the quarter, despite Netflix arguing retention ‘remains at a very healthy level (we believe among the best in the industry).’ The streamer also noted that its Russian exit was responsible for the loss of 700,000 subscriptions. Excluding this one-off impact, it actually added 500,000.

However, Pivotal analyst Jeffrey Wlosarczak called it a ‘shocking 1Q subscriber miss,’ downgrading Netflix from a buy to a sell. Meanwhile, Wells Fargo analysts believe ‘negative sub growth and investments to reaccelerate revenues are the nail in the NFLX narrative coffin.’ Billionaire hedge fund manager Bill Ackman sold his 7% holding which he only acquired in January, tanking a $400 million loss.

But with 221.6 million subscribers, Netflix is still the largest subscription streaming service in the world ‘on all key metrics: paid memberships, engagement, revenue and profit.’

Where next for Netflix shares?

However, Netflix projects it will lose another 2 million subscribers in Q2. The FAANG company argues that it’s ‘increasingly clear’ that growth depends on factors outside of its control, such as the uptake of broadband-connected TVs, as well as macro factors including the economic environment, Ukraine war and continued pandemic disruption.

And it admitted that ‘over the last three years, as traditional entertainment companies realized streaming is the future, many new streaming services have also launched,’ with the increased competition also affecting its growth potential.

But it also estimates that Netflix accounts are being shared with over 100 million non-paying households. The streamer argues this ‘means it’s harder to grow membership in many markets,’ and that ‘our relatively high household penetration - when including the large number of households sharing accounts - combined with competition, is creating revenue growth headwinds.’

This has left Netflix considering ‘how best to monetize sharing’ as the pandemic-induced subscriber surge comes to an end. It accepts that the practice ‘likely helped fuel our growth,’ but that the ease of sharing within a household has ‘created confusion’ about ‘when and how’ account sharing can occur outside of a household.

Accordingly, it’s testing ‘new paid sharing features’ in Latin America, saying ‘while we won’t be able to monetize all of it right now, we believe it’s a large short- to mid-term opportunity.’

This could be a PR disaster in the making. Only five years ago it tweeted ‘love is sharing a password.’ And it’s assuming that beneficiaries of password sharing will pay for an account; many households share different streaming services.

Worse still, while CFO Spencer Neumann said in March 'it's not like we have religion against advertising,’ CEO Reed Hastings has gone a step further, arguing he was ‘against the complexity of advertising, and a big fan of the simplicity of subscription…but as much as I am a fan of that, I am a bigger fan of consumer choice.’

Netflix has already increased prices across most regions this year. Stopping account sharing and even inputting adverts could give hard-pressed subscribers even more reasons to leave.

Kantar research says 1.51 million streaming subscriptions were cancelled in the UK in Q1 2022, with consumers ‘starting to seriously prioritise where and how their disposable income is spent.’ However, Kantar consoled that ‘Netflix and Amazon can be seen to be hygiene subscriptions for Brits; the last to go when households are forced to prioritise spend.’

Netflix originally became popular because it was the only streamer, with all the content consumers wanted instantly and for a reasonable price. With a dozen competitors now online, it’s fighting to retain its slice of the pie. And with content split between providers, many will resort to piracy, making the pie itself smaller.

While Q1’s subscriber loss is little more than a rounding error, Netflix’s growth story may be over.

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