‘Is There a Prescription for Subscription Attrition’

Celadna, Czechia - 04.21.2022: Approximation of Netflix logo with letters falling down as from the cliff. Concept for shares plummeting, valuation decrease, company crisis. Stock price plunge

Once the domain of cathode ray tubes and rabbit ears wrapped in aluminum foil, the world of television has come to be dominated by internet streaming services, most notably Netflix.  Streaming video since 2007, Netflix has become a staple of pop culture with over 222 million households across the globe paying to use its software. Thus, the biggest financial news of last week occurred when the company announced its first decline in paid users in more than a decade during the first quarter (Q1) of 2022 and projected substantial subscriber losses for the following quarter.

Netflix had given guidance in January that it expected to gain 2.5 million users during Q1 of 2022. This was significantly smaller than the 4 million added during the first quarter of 2021 and the projection of reduced user growth caused the stock to plunge more than -20%.  Last Tuesday, Netflix announced in its quarterly earnings report that it had actually lost 200,000 subscriptions during the first three months of 2022 and that it expected to lose 2 million more over the next three months. The jarring disconnect between company guidance and company numbers caused the stock to plummet another -35%.

A regional breakdown of the subscription changes in the chart above shows that while Netflix lost 600,000 subscribers in North America, it would have still gained over 500,000 new users worldwide if it hadn’t voluntarily stopped service to 700,000 households in Russia because of the war in Ukraine. Nevertheless, the user growth numbers are currently trending in the wrong direction. Concerns about competition from the numerous alternative streaming services and fears that recent subscription fee hikes might scare away more price-sensitive customers made Netflix more pessimistic about near-term growth and investors more bearish on the company’s ability to maintain a steadily increasing stream of recurring revenue from subscriptions.

During interviews last week,  Netflix management told investors that the company would double down on “creative excellence” and be more disciplined about production costs in order to compete more successfully with other streaming companies. Executives also mentioned that Netflix would be more aggressive in collecting revenue from the 100 million viewers it estimates watches its content for free by using shared passwords. The exact methods to monetize the millions of moochers were still being discussed.  

Overall, Netflix has shed more than 68% of its market value since its most recent price peak in mid-November of last year, its biggest drawdown since the company attempted to spin-off a new corporate entity called “Qwikster” in 2011.  Back then, Netflix still generated revenue through its original DVD-by-mail business, but the company could see that streaming was the future, so it attempted to spin-off the DVD service under a cool new name  “Qwikster”. Complaints that the plan would bring new fee increases and disruption in current services caused Netflix to lose over 1 million subscribers and its stock to draw down over -80% from its previous high. Of course, following this corporate blunder, Netflix would go on to spend the next decade as one of the market’s pre-eminent technology growth stocks. 

In the end, the best example of subscription stability and theft prevention that Netflix could emulate may not be found in the technology space but in the boring world of brick-and-mortar retail. Earlier this spring, Costco announced that its memberships increased 7% last year with corporate earnings growing at a 16% annualized rate over the last five years. The company attributed the growth to keeping things simple – low prices, limited selection, and good execution. There is also very little churn in Costco memberships with renewal rates of membership fees around 90%.  And thanks to single-entrance stores, employees checking receipts, bulky products, and only allowing members as customers, Costco loses far less revenue to theft than other retailers – about 0.1% a year compared to a median rate above 3%. Thus, Costco memberships have all the qualities Netflix wants in its subscriptions. Could the streaming company achieve this level of stability? Well, stranger things have happened to Netflix.

Performance is no guarantee of future results.   Trend signals are proprietary research of EWM Investment Solutions, a wholly owned subsidiary of Executive Wealth Management, LLC. Data source for returns is FactSet Research Systems Inc. This chart is not intended to provide investment advice and should not be considered as a recommendation.  One cannot invest directly in an index. Executive Wealth Management does not guarantee the accuracy of this data.

Model Updates

Last week, the EWM stock models – Equity Growth, Equity Dividend, and Emerging Growth Companies – made some incremental shifts in position weightings away from volatile and cyclical sectors towards more stable areas like consumer staples.  There were no other trades in the EWM Investment Solutions models during the week ending on April 23rd, 2022. Domestic equity market sectors still maintain their long-term favorable trend and their overweight position versus international stocks in EWM’s Asset Allocation models.

Quote of the Week

In a role reversal, Netflix now finds itself as the streaming incumbent facing emerging competition.

Wells Fargo stock analyst Steven Cahall commenting to Barron’s last Wednesday following Netflix announcement of subscription attrition in 2022.

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Returns are calculated as indicated below with reinvested dividends not considered except for the Barclays U.S. Aggregate Bond Index. Data source for returns is FactSet Research Systems Inc. The London Gold PM Fix Price is used to calculate returns for gold.

1 Week = closing price on April 8, 2022 to closing price on April 14, 2022

  1 Month = closing price on March 14, 2022 to closing price on April 14, 2022

  3 Month = closing price on January 14, 2022 to closing price on April 14, 2022

YTD = closing price on December 31, 2021 to closing price on April 14, 2022

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