Markman Capital Insight

Netflix Reels From Russia And Competition

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The best bull markets ignore almost all news events. Traders do not care about unique disruptions like pandemics or wars. Macroeconomics get a blind eye, too.

That makes the action late Tuesday in Netflix (NFLX) unusual.

The streaming media giant’s shares slumped 25% in after-hours trading after executives noted that global subscriptions fell for the first time in a decade. Closed Russian operations factored heavily in the shortfall.

The reaction is trouble for businesses with big Russian exposure.

In fairness, subscriber misses have been common at Netflix. While the Los Gatos, Calif.-based company has been a terrific business overall, its financial reporting history is littered with washouts following missed quarters. Part of this is the nature of the business.

Executives at Netflix are long-term planners.

Reed Hastings, chief executive officer transformed the company in 2009 from a mail order DVD rental outfit to the world’s first streaming network. Today the company has 222 million paying subscribers, a remarkable accomplishment during the course of only 13 years. Getting there involved patience and ignoring a lot of the short-term pain that came from operational choices, like price increases and huge investments in content creation.

Like so many Western corporations Hasting made the snap decision in March to suspend operations in Russia following the Ukraine invasion. The Yale School of Management reported this week that  that 750 corporations have left, or are planning to close Russia franchises this year.

Financial performance last quarter was clearly impaired at Netflix. Hastings notes the company lost 200,000 paying subscribers in the first quarter ended March 31. Earlier in March, Netflix suspended all streaming operations in Russia, forfeiting about 700,000 Russian accounts.

Unfortunately for shareholders, traders are not treating the Russian choice as an extraordinary event. Shares lost $90 in after-hours trade on Tuesday, sending shares very near their pandemic lows at $260.

It doesn’t always work that way. In good stock markets traders ignore bad news.

During the latter part of 2020 investors turned a blind eye to the pandemic and all of the ensuing macroeconomic fallout. They looked past shuttered storefronts and rampant unemployment. And when executives at public companies refused to give forward guidance, that didn’t matter either.  Stocks rallied. Investors concluded that the news was extraordinary and could not get worse.  

Cumulative earnings for the benchmark S&P 500 index peaked December 2019 at $139.55, with index trading at 3,230. As the pandemic raged in 2020, earnings sunk during the next three quarters by 15.4%, 32.2%, and 8.2% respectively. Despite this, the benchmark pushed higher to 3,756.  

The woes at Netflix may be a special situation.

The business faces increased competition from other media streamers like Walt Disney (DIS), Amazon Prime Video and YouTube. These platforms use a blend of paid subscriptions and advertising-based video on demand to give consumers content at reduced prices. Traders may simply be reacting to Netflix being unprepared in that marketplace.

Then again, maybe traders are going into the second quarter financial reporting season with their eyes wide open. Perhaps Netflix is a harbinger if things to come. Perhaps traders will not look past sales and earnings shortfalls tied to Russia. If that proves true, some firms are in big trouble.

McDonalds (MCD) has 850 stores in Russia and they have all been closed since March. PepsiCo (PEP), StarbucksSBUX (SBUX), and Yum Brands (YUM), the parent of KFC and Pizza Hut restaurant chains, also have extensive shuttered Russian operations. And the cigarette maker Philip Morris International (PM) derived 8% of its 2021 sales from Russia, according to a note in Barrons.

EPAM Systems (EPAM), a software development company, has even more exposure. The company was founded by Arkadiy Dobkin, a Belarus emigre. The company maintains most of its operations in Eastern Europe. Half of its 60,000 employees are located in Ukraine, Russia and Belarus. Business can’t be great.

It’s still too early to tell if the reaction to the results at Netflix is about competition or Russia. All the same, investors should be alert. There is a chance another shoe in the Russia saga is about to drop.