Netflix Q2 19 – Risky business

Netflix is now a studio.

• A great set of results was disfigured by slower user growth as price increases and the verticalisation of the content industry means that Netflix must now stand on the quality of its own content only.
• Subscribers grew by 2.7m to 151.56m but this was well short of the company’s forecast of 4.7m and the 5.0m net adds that were expected by the market.
• The subscriber slowdown was the most acute in regions where Netflix has been forced to increase prices in order to keep up with its heavy content spending.
• However, the financials were fine with Q2 19 revenues / EPS at $4.92bn / $0.60 compared to consensus at $4.93 / $0.56.
• The problem that Netflix has always had is now coming home to roost as the content owners whose content it has distributed for years have now decided that they want to go direct to the consumer.
• The biggest loss is Disney which is now launching its own Disney+ service but also a re-emboldened AT&T is increasingly moving towards going direct with its own service as is Apple.
• The net result is bad for consumers because their experience is becoming much more disjointed and fragmented.
• This makes discovery and recommendation of content much harder as content that the consumer will like will be increasingly spread across numerous unconnected services.
• Netflix is not about to recommend a show on Disney+ because its consumers happen to like House of Cards.
• The solution to this problem is either one of the content providers takes over, crushes the rest and forces them onto its platform or there is an independent indexation and cross-referencing system put in place.
• Both of these will take a long time to come to fruition meaning that greater fragmentation is likely to be the outlook for now.
• Against that backdrop, Netflix is now subject to the hit and miss nature of content creation as much as anyone else.
• The one thing it has going for it is its huge user base meaning that it now must irrevocably hook them into its own content such that they won’t want to leave an go elsewhere and be happy to pay up.
• This brings us right back to content where it has a few hits like Stranger Things and Orange Is the New Black, but it faces competition from far larger and better-financed rivals.
• This means that they can outspend Netflix which is already very heavily indebted.
• Netflix’s future now hangs on having a string of hit shows that can match the popularity of Game of Thrones or Chernobyl in order to keep its user base happy.
• Failure will mean falling users as they move away and spend their money on other services leading to the possibility of being forcibly acquired.
• All of the risk now lies in content which given its precarious nature, the current $150bn market cap and the $12.5bn debt is a risk that is too rich for my blood.