Netflix Should Just Admit That Growth Is Slowing

Last week, Netflix (NASDAQ:NFLX) confirmed that its subscriber-growth slowdown continued in the second quarter, as expected. The streaming video pioneer cast this slowdown as temporary, driven by the pandemic’s impact on at-home entertainment consumption and original-content production schedules.

However, evidence that Netflix’s growth is slowing continues to mount. Management should acknowledge this reality rather than resorting to increasingly convoluted arguments to “prove” that its underlying pace of growth hasn’t changed.

The slowdown emerges

Three months ago, Netflix reported that it added 4 million paid subscribers in the first quarter (net of cancellations). That fell short of its quarterly forecast of 6 million paid net subscriber additions. Moreover, the company projected that net paid subscriber growth would slow to just 1 million in the second quarter.

Perhaps in an effort to head off a shareholder panic, Netflix executives described the growth slowdown as a timing issue. The COVID-19 pandemic pulled some subscriber gains forward into 2020, when Netflix posted record growth. A light content slate in the first half of 2021 — caused by pandemic-related production delays — also contributed to the slowdown.

Netflix’s management asserted that this blip in growth wouldn’t last long. “We anticipate paid membership growth will reaccelerate in the second half of 2021 as we ramp into a very strong back half [content] slate,” the company wrote in its first-quarter shareholder letter.

More signs of longer-term deceleration

In the second quarter, Netflix grew its global paid-subscriber count by 1.54 million. This beat the company’s forecast of 1 million paid net adds but still represented the lowest quarterly increase in subscriber numbers since 2013, when the company was a fraction of its current size. Even more significant, Netflix projected that it will add 3.5 million paid subscribers globally in the third quarter, well short of the analyst consensus of 5.9 million paid net adds.

Once again, Netflix’s management tried to paint the guidance as being consistent with previous trends. CFO Spencer Neumann noted that if Netflix meets its Q3 subscriber guidance, it will have added over 54 million net paid subscribers over the trailing two-year period — roughly in line with its 56.45 million net paid additions in 2018 and 2019 combined.

However, that two-year period includes the big subscriber surge at the beginning of the pandemic. Netflix’s guidance for 3.5 million paid net adds this quarter compares to 6.77 million in Q3 2019 and 6.07 million in Q3 2018. This strongly suggests that Netflix’s underlying growth has moderated compared to 2018 and 2019, particularly because Netflix can no longer blame a lack of new content for its slower growth.

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Face the facts: They aren’t that scary

Slowing growth shouldn’t come as a surprise to Netflix shareholders. Thanks to the service’s amazing success over the past decade, Netflix is virtually ubiquitous in the U.S. and Canada — and not far behind in much of Europe. That naturally makes it harder to keep adding 27 million or more subscribers annually.

Shareholders need not fear this slowing growth. Netflix already generates strong earnings, with operating income on track to reach $6 billion this year. It has ample room to grow its revenue and expand its margins in the coming years, with periodic price increases picking up some of the slack from slower subscriber growth.

Management should stop implying to shareholders that growth will snap back to 2018/2019 levels next quarter or next year. While that could happen, it seems fairly unlikely at this point. Instead, management should acknowledge that subscriber growth has peaked and encourage investors to focus more on Netflix’s long-term earnings and free cash flow potential, rather than pure subscriber growth.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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View more information: https://www.fool.com/investing/2021/07/24/netflix-should-just-admit-that-growth-is-slowing/

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