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Netflix (NFLX) shares were hit hard Tuesday, July 19, plummeting from $90 to $77.58 a share before rebounding to $79.52 by the end of the week. The culprit is slowing growth and that has disastrous future implications.
There was a time when Netflix could do no wrong. It switched business models on the fly, opting for Internet streaming versus mail order DVD shipping. Subscribers ballooned. It started producing its own content in addition to licensing deals from Hollywood and broadcast networks. Subscriber growth surged more. It even raised prices. Subscriber growth exploded, shooting to 69 million by January 2016. It all seemed too good to be true. That’s because it was. Subscriber growth wasn’t growing rapidly because the firm was changing itself in clever ways. The impressive growth was the result of aggressive expansion into new countries leading to 25 million subscribers outside of its U.S. home market.
Co-founder Reed Hastings is not shy about his ambitions. He’s building Netflix to be thefirst truly global broadcast network, a behemoth that becomes increasingly more valuable to customers because of the growth of its network. The network effects of that growth means better content, larger profits and even more growth. It’s all good until growth slows.
By all accounts, that’s what is now happening. Monday after the close the company reported it added only 1.54 million new subscribers in the second quarter. This was far below its own forecast of 2.5 million. Hastings said the weak growth is the result of churn. Existing subscribers are choosing not to renew given recent price increases. In fact, Netflix claims it added a sufficient number of new subscribers to meet the its modeled projections. It just lost more than it planned.
While all of that may be true, it’s sobering news for a company with supposed powerful network effects. Net new subscriber growth is slowing dramatically. Existing customers are unwilling to pay higher prices.
All of this comes at a time when Netflix is flexing its muscle by procuring content with costly longer-term licensing deals. It will spend $5 billion this year, a number that should mean it can easily outbid the competition. However, recently smaller players have begun divvying up geographic regions.
Nordic streamer Viaplay wants to work with an Australian firm called Stan. Lightbox from New Zealand is in talks with Hulu from the U.S. And Bell Media in Canada is discussing options with Foxtel in Australia and Sky TV in Europe. Even if these mergers of convenience don’t yield winning bids they’re going to push up prices for Netflix. That’s going to put more pressure on profits and its ability to get bigger faster.
It’s not as though that would have been easy anyway. With operations now in 190 cosmopolitan countries Netflix has picked the best low hanging fruit for quick subscriber growth. Cracking new markets will mean buying up local content with considerably less global appeal. In other words, it’s going to be expensive, hard work adding millions of new subscribers from smaller, underserved markets.
And that’s not even taking into account the elephant in the room: Amazon Prime video. As part of the flywheel of Amazon proper, it’s certainly not going away no matter how little money it makes.
Netflix proved the early naysayers wrong, growing exponentially. The growth of its network made it more valuable to subscribers, leading to more growth. Now that growth is slowing and competitive alliances will make future growth even tougher. What happens when a growth stock stops growing? It becomes exponentially smaller. Orange is the new red.
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About Jon Markman: A pioneer in the development of stock-rating systems and screening software, Jon Markman is co-inventor on two Microsoft patents and author of the bestselling books The New Day Trader Advantage, Swing Trading and Online Investing, as well as the annotated edition of Reminiscences of a Stock Operator. He was portfolio manager and senior investment strategist at a multi-strategy hedge fund from 2002 to 2005; managing editor and columnist at CNBC on MSN Money from 1997 to 2002; and an editor, investments columnist and investigative reporter at the Los Angeles Times from 1984 to 1997.