• Netflix’s Q4: Cold Hard Reality in the U.S. Sets In

    Netflix reported its Q4 ’19 and full year results yesterday, exposing the cold hard reality it is facing in the U.S. While the company gained 8.8 million subscribers globally (ahead of its 7.6 million forecast), it gained just 420K in the U.S. specifically (compared to 600K forecast). To put the 420K into more context, it’s by far the lowest Q4 US sub add since Q4 ’11 following the Qwikster debacle. It’s the first time since then that U.S. sub additions have fallen below 1 million in the seasonally strong Q4. And it’s down a whopping 79% vs. just 2 years ago, in Q4 ’17 when Netflix added 1.98 million U.S. subscribers.

    Now some will say the “law of large numbers” is catching up with Netflix and that’s true to an extent; it’s a lot harder to add a million subscribers off a base of 60 million than it is off a base of 20 million. But this explanation just scratches the surface of what’s happening now at Netflix.

    In its investor letter, Netflix explained its anemic UCAN (U.S. plus Canada, a new reporting region) performance by saying it “is probably due to our recent price changes and to U.S. competitive launches.” In other words retention/churn and acquisition, respectively.

    The price changes are from May, 2019, when Netflix raised the price of its most popular plan from $11/mo to $13/mo, among other rate increases. So the first explanation for the Q4 slowdown is higher churn (a number Netflix no longer breaks out) / lower retention even though the price increase was fully implemented 5 months before Q4 even began. And remember, Q4 included the launch of “The Irishman,” the most talked about and star-studded movie of 2019 and Netflix’s biggest swing at movies to date.

    As far as the competition goes, we’re all aware that Disney+ and Apple TV+ launched in Q4 to much fanfare. But back on Oct. 16th, when Netflix reported its Q3 results, it included 5 full paragraphs with its views on the changing competitive landscape. The strongest statement made about competitive impact to Netflix was “There may be some modest headwind to our near-term growth, and we have tried to factor that into our guidance.” Meanwhile there were a lot of words of optimism: “very large market opportunity,” “new competitors have some great titles (especially catalog titles), none have the variety, diversity and quality of our new original programming,” “likely outcome from launch of these new services will be to accelerate the shift from linear TV to on demand consumption,” etc.

    Why does any of this matter? Because Q4 provided anyone paying close attention with an important preview of what’s to come for Netflix in 2020. In 2019, in the seasonally slow second quarter, Netflix lost U.S. subscribers for the first time since Qwikster, around -130K. A light content slate was the main explanation given. But Q2 ’19 was before the onslaught of Disney+, Apple TV+, Peacock, and soon HBO Max. It was also before “Friends” was pulled from the service.

    At the time I remember thinking “geez, if Netflix lost U.S. subs in this benign competitive environment, what’s going to happen in Q2 ’20 given the above?” And I pretty much concluded Netflix will lose even more subs in Q2 ’20 than the 130K U.S. subs it lost in Q2 ’19. After seeing the Q4 ’19 results, it’s even more likely to happen. But now something more eye-opening may occur that would have been unthinkable less than 2 years ago: Netflix may lose UCAN subscribers in the seasonally strong FIRST quarter of 2020. Note Netflix did not give a UCAN-specific Q1 forecast, just a global one, which was 7 million, down 2.6 million from 9.6 million added in Q1 ’19.

    To put this in context, in Q1 ’19 Netflix added 1.88 million UCAN subscribers with EMEA, LATAM and APAC combined adding 7.09 million. If these international segments just kept growth flat, then UCAN would have to lose 100K subs to get to the net 7 million Netflix is forecasting. But, Netflix said all 3 of these segments had RECORD sub growth in Q4 ’19, so unless their leash really gets snapped back for a reason I can't think of (and if it does then say goodbye to the 7 million global net sub add too), these regions will almost certainly grow by more than 7.09 million in Q1 ’20. The simple math is that the more they exceed 7.09 million, the greater the UCAN sub loss has to be in order for the net global result to equal 7 million. Just given what Netflix has presented, I would peg the odds of a UCAN sub loss in Q1 ’20 at 50-50.

    Netflix is in uncharted territory. The competitive landscape is completely new. Its prices are higher than market expectations, primarily because of super-agressive pricing from Disney+, Apple TV+ and Peacock (regardless of Netflix's greater volume of its original content). It said again, on yesterday’s earnings call, that it has no interest in launching a lower priced ad-supported tier, even though doing so would be like picking up money off the floor given connected TVs’ popularity and re-energize sub growth, citing a non-sensical “we can’t chew gum and walk at the same time” resistance to investing in data and a “we can’t even suit up to compete with Amazon, Google and Facebook" logic (never mind that Hulu, CBS All Access, etc, etc are generating hundreds of millions in ad revenue already, competing quite effectively). And international, which has been the key to the company’s recent success, is also going to have different competitive dynamics (Disney couldn’t resist tweaking Netflix yesterday by announcing it is accelerating the Disney+ launch to March 24th in 8 key EMEA countries).

    Back to Netflix citing “modest headwind” in October with respect to competition. A more accurate reference would be to say Netflix is encountering the front end of a Category 5 hurricane that made landfall in Q4 and is going to sweep across Netflix over the next 12-24 months. With each quarterly report we’ll all learn how much damage is left in its wake, and the cold, hard reality Netflix is facing.