4C - leaderboard - 4-25-18
  • Netflix is Bedeviled by Domestic Subscriber Forecasting

    Netflix reported a large miss on its subscriber forecast in Q2, with 670K net additions in the U.S. (44% below its forecast of 1.2 million) and 4.47 million net additions internationally (10% below its forecast of 5 million). From my standpoint, the international miss is almost irrelevant because the segment includes so many different countries with so many different adoption patterns that Netflix is still new to understanding. With all of those moving pieces, missing by just 10% isn’t too shabby.

    Conversely, the domestic miss of 44% is a real head-scratcher which I believe raises, yet again, real questions around how well the company understands the dynamics of the domestic SVOD market, how much growth remains and how well its forecasting function is run. For eager investors, who have bid up the stock on lofty expectations, getting a handle on these issues seems critical.

    This is far from the first time Netflix has missed its domestic forecast, though most quarters, when it beats its forecast, there’s little attention paid. When it has missed its domestic forecast, the company has offered a range of reasons (e.g. in Q2 ’16 it pinned the blame on press coverage of price increases, back in Q3 ’12 it cited pressure from Olympics viewing).

    In fact, on yesterday’s earnings call, referencing the Q2 ’16 miss, CEO Reed Hastings said, “we’ve seen this movie before….and we never did find the explanation of that other than there is some lumpiness in the business and continued to perform after that.”

    As always, Netflix management seems earnest about its forecasting, noting that what it shares publicly are its actual internal forecasts. But still, in the domestic market, where Netflix has been streaming for over 10 years and now has over 57 million subscribers, it’s bizarre that the company doesn’t have a better handle on subscriber dynamics.

    As with all subscription businesses, Netflix’s net quarterly number is a product of existing subscriber retention and new subscriber additions. In the first category, I would have thought that by now Netflix would have a pretty refined model for predicting churn based on proven correlating factors like new content released, subscriber duration, price increases, competitive events (e.g. Olympics), etc. that would all roll up into a relatively accurate picture of retention.

    Similarly, on the additions side, I’d expect that by now Netflix would be well-versed in the conversion effectiveness of all available marketing tactics, based on prior experience. So once the quarterly budget and tactics are set, additions would come in pretty close to expectations.

    But the 44% domestic miss shows that I’m wrong. Netflix didn’t offer any specifics on either retention or additions domestically, instead focusing on its rolling 12 month performance and strength of its fundamentals. To be sure, overall Netflix continues to grow nicely (5.2 million total subscriber additions in Q2 is nothing to sneeze at) as the company is riding the global shift to streaming.

    But the Q2 domestic miss shows that oddly, Netflix still does not have a really strong handle on forecasting domestic net subscriber additions, nor does it seem overly concerned about this. There’s a black box factor to Netflix’s domestic growth that won’t be changing any time soon. That suggests the likelihood of volatility in Netflix’s stock price will remain high.

     
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