Although it is profitable and revenues grew strongly in the latest quarter, it wasn't enough to please investors
It’s not easy being the king. When it comes to streaming video, one of the media and entertainment sectors that investors are the most excited about, Netflix NFLX is definitely one of the top names — and that’s usually a good thing. But it also means that expectations are exponentially higher, and the penalty for missing them can be even more painful.
Netflix saw the downside of that relationship on Wednesday, when it turned in lower-than-expected growth numbers. The company’s share price tumbled by as much as 14% in after-hours trading, wiping billions of dollars from its market value.
Unlike some media companies, Netflix is solidly profitable, but its profit of $29 million or 7 cents a share for the most recent quarter missed the consensus estimate (which was 8 cents). The profit number was also sharply lower than the 14 cents the company made in the same quarter the previous year. And while revenue grew by more than 23% to $1.74 billion, that also happened to come in just below consensus estimates.
Perhaps even more worrisome than the hard financial numbers, however, was Netflix’s subscriber performance. After leading analysts to believe that it would likely add close to 1.2 million domestic subscribers in the quarter, the company only managed to grow its user base by 880,000.
Netflix CEO Reed Hastings blamed the lower subscriber number in part on higher-than-expected “churn,” which is industry jargon for the number of people who drop their subscriptions, something the Netflix chief executive said was a result of the shift by credit-card companies to chip-based cards. That caused difficulties in processing some payments by subscribers, Hastings said.
The company said that international growth was higher than expected — it added 2.7 million subscribers, compared with estimates of 2.4 million — but the weak U.S. numbers were likely troubling to many. To make matters worse, the forecast for domestic subscriber growth in the next quarter was also below estimates.
With a stock like Netflix, which has increased in value by more than 110% this year, the price includes a hefty premium based on the expectation that the pace of growth will continue. Any sign of weakness or a drop in momentum is inevitably going to set off some warning bells.
Is Netflix damaged goods in some fundamental way? Not really. The company is still growing rapidly, and expanding into new markets — something it has said for some time it would be focusing on. The higher than expected international subscriber number it reported is evidence that this strategy is working.
Netflix is also plowing money into developing its own content instead of just licensing it, which is supposed to help with long-term growth. But that also means higher costs — which helps explain both the weakness in profit and the fact that the company recently raised the price of its streaming service in the U.S. and Canada to $9.99 from $8.99.
In the long run, Netflix is still one of the few companies that is well-positioned to benefit from the generational shift away from cable packages to on-demand streaming services, and that will continue to make it valuable for anyone wanting to invest in the future of video content. But being a pioneer has its downsides, and lofty expectations is one of them. It’s great when you meet them, not so good when you don’t.
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