Netflix shares dive over missed subscriber growth projections

Netflix shares plunged as the entertainment streaming company missed its subscriber forecasts by one million for the second quarter.

The group reported that it had closed the quarter with 130m subscribers and admitted: “It has been a strong quarter but not an excellent one”. The company expected to add 6.2m new subscribers in this period but it only managed 5.2m. FactSet analysts expected a total of 130.78m clients by the end of the quarter.

Profits came in at $384m, or $0.85 per share, higher than internal forecasts of $358m. Earnings were up 42%year-on-year to $3.8bn.

For the next quarter, Netflix forecast a 33.6% year-on-year rise in earnings to $3.9bn and profits of $307m ($0.68 per share).

It estimated a 5.15m increase in subscribers to 135m, below analysts expectations of 6.3m new subscribers.

Paul Verna, principal analyst at eMarketer, said: "Netflix disappointed with a weak Q2 2018 but this isn’t entirely surprising given rising competition in the video streaming market, where Amazon, Hulu, HBO and others are gaining share of subscription video dollars at Netflix’s expense. The market is also heating up with new entrants in the SVOD space, including Disney and AT&T."

"Despite the weak quarter, and a lowered outlook for Q3, eMarketer expects Netflix to remain the clear leader among video streaming services in the US. Netflix has a strong slate of original content that should keep it in the forefront among streaming services, and it plans to continue outspending the competition to develop TV programming and feature films. This is critical in an era when people increasingly choose streaming services on the strength of their content."

Russ Mould, investment director at AJ Bell, said Netflix investors were suffering a rare reverse over disappointment in the subscriber addition number. "But nerves over the subs figure relay reflect the company’s lofty valuation and how the company is still a long way from generating the sort of cash flow that would justify its $155bn market capitalisation."

Management also added to investors’ nerves by predicting the next quarter would grow at a similar run rate, lower than analysts.

“This could be just the law of large numbers taking over although it could also reflect competition from established broadcasters, as well as Amazon, which is making ever-greater strides in the field of content creation and delivery," Mould said.

“It would be wrong to judge Netflix on the basis of just the one quarter and the mildly disappointing outlook, as least relative to consensus forecasts, and the company’s business model still looks much stronger than that of Spotify for example.

“Both run a subscription model, which can make for loyal (or sticky) customers who also pay upfront, which is good for cash flow. This model is also more predictable than transaction-based fees, or the advertising-based approach.

“However, Netflix pays for and develops content as a fixed cost, so the more subscribers it has, the lower the costs relative to revenues and the higher its profits and cash flow. By contrast, Spotify pays for content based upon the number of song downloads, in the form of royalties, so its costs rise to some degree as revenues grow."

Despite a record operating profits of $462m in the three-month period, Mould said the question remains whether Netflix is generating enough profit and cash flow to support its monster $155bn market valuation. After the post-results stumble the shares trade on more 155 times earnings, compared to a multiple for the S&P 500 of 16 times, based on consensus earnings forecasts.

“In addition, the company is still burning cash and piling up debt as it funds the development of its content library and thus customer acquisition."