If you detected the wind pattern figuratively shift around 4:01pm Eastern Time yesterday, you weren’t imaging it. Rather, the shift was due to the collective exhaling of Netflix stockholders who were justifiably on edge about the company’s Q2 2021 earnings report, and in particular its subscriber additions, especially in the all-important UCAN (United States and Canada) region.
Q2 2021 was the first quarter to be comp’d against a full Covid quarter, Q2 2020. It is old news that Covid created many major distortions in the economy, but perhaps the biggest distortion (aside from the bizarre run on toilet paper) was the massive acceleration in streaming and connected TV. And few companies benefited more from shelter-in-place orders than Netflix, which in Q2 2020 gained over 10 million global subscribers, on top of the 15.8 million it added in Q1 2020.
To say that first half 2020 would be a tough act to follow in UCAN would definitely qualify for the understatement of the year award. Netflix said last year that it was experiencing a “pull forward” in demand. Results in Q1 2021 began bearing that out with global subscriber additions coming in at 3.98 million, obviously way down from the freakish first quarter of 2020, but also just a fraction of the 9.6 million global subs that Netflix pulled in back in Q1 2019.
But Netflix has done a masterful job of calibrating investors’ lofty expectations for years now, only rarely jolting them from their blissed-out state with a surprise here or there. Overall, stock price hiccups have presented opportunities for the truly faithful to keep buying in; those that have done so have been consistently rewarded.
Three months ago Netflix issued an anemic Q2 subscriber forecast of just 1 million global subscribers, way down from Q2 2020's craziness, but also from the 2.7 million gained in Q2 2019, with a “flattish” UCAN (“+/- a couple hundred thousand” paid net subscriber adds) expected. Justifiably the Covid pull forward was to blame. But that tough message to Wall Street was wrapped in the soothing reassurance clearly stated in the first paragraph of the April letter to shareholders that the company anticipated “a strong second half with the return of new seasons of some of our biggest hits and an exciting film lineup.” The stock lost 7.3% the day after the Q1 2021 earnings report, but was fully back as of last week.
Now Netflix has always said it shares its own internal forecasts as its external forecast. And given that the guidance is delivered with the prior quarter’s earnings (and hence about 3 weeks into the current quarter), absent big macro changes (e.g. Covid), the forecast should be pretty reliable. Except some quarters it’s been inexplicably too high or too low (the latter has sometimes then resulted in “the dog ate my homework” excuses which have periodically dented trust in management). In short, serious Netflix watchers know forecasts cannot be truly taken to the bank.
A blinking red light went off July 15th when Bloomberg reported the planted story that Netflix was planning to expand into video games and had hired Mike Verdu, a former Electronic Arts and Facebook executive. The gaming adjacency not only makes a lot of sense for Netflix, but also excited investors who saw a potential gusher of new revenue. But the grizzled among us found a different interpretation: Netflix was doing what public companies do when they have tough upcoming news to share…try to distract investors with a shiny new object.
All that brings us to yesterday afternoon and where the second quarter subscriber acquisition numbers were going to come in. A major unexpected fall off, say a million or so in UCAN alone, would have been deeply troubling and likely sent the stock spiraling in after-hours trading. Instead the UCAN loss was only 430K, worse than the “+/- a couple hundred thousand” predicted loss and but not terribly worse than the 130K lost in Q2 2019. The three other regions gained 1.97 million subscribers, well down from Q2 2020 (7.16 million) but not terribly down from Q2 2019 (2.83 million)
But that was more than enough to placate Wall Street. The stock held up nicely in after-hours even as the company was mixed on other target financial metrics. It was down just over 4% as I post this, with the NASDAQ up .4%. And as for that gaming revenue gusher? Netflix quashed investors' hopes, explaining gaming won’t have a standalone revenue stream and will only exist to support the SVOD business.
For Netflix investors it was a “whew!” moment, another dodged bullet. I have been predicting for a long while that a day of reckoning was coming for UCAN subscribers, which Covid completely obscured. Contraction is now here (at least for Q2) but there was no sign of any visible cliff. Netflix has been able to mainly co-exist with Disney+, HBO Max and all the other would-be “Netflix killers.”
Meanwhile, as VideoNuze readers know, I have long advocated for Netflix to introduce a lower-priced ad-supported tier in order to give consumers more choice (here and here and here), expand the company’s total addressable market, and not fall out of step with the competition’s approach. But Netflix has consistently resisted the idea; on yesterday’s earnings call it never even came up. I am still hard-pressed to understand Netflix’s religion on this and given how hot the CTV ad space is, I’m stumped that Netflix is so willing to forego this huge opportunity even as others race ahead and consumers come to expect lower-priced options. Netflix is eager to sell its subscribers all manner of fandom merchandise, but it's drawing the line at offering an ad-supported tier. Will someone please explain this choice to me?
To be clear, Netflix is still the world’s number one SVOD player. There is a good chance it always will be. It is a well-run company that sets reasonable growth and financial metrics which it typically meets, and more often beats than misses. And it is in the investor relations Pantheon for how well it has managed Wall Street’s sometimes insane expectations, no mean feat given the volatile conditions it has grown up under. Yes, Netflix is a one-horse SVOD company as Colin says...but that horse is proving to be pretty durable under a huge array of circumstances. At least so far.
(Update: Netflix stock closed the day down 3.3% while the NASDAQ gained .92%)