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Investors are freaking out that Netflix lost 200,000 subscribers—but that’s not even its biggest problem

April 20, 2022, 11:00 PM UTC

In July 2019, I wrote two stories suggesting that Netflix stock was highly overpriced. Netflix stock had just sold off by more than 10% following the release of disappointing numbers showing tepid subscriber growth. Even so, I noted that the streaming giant still harbored “a gargantuan market cap relative to its still puny earnings,” and that since the course of its stock depended greatly on its ability to attract new customers at an incredibly rapid pace, the slowdown could spell trouble. Its failure to meet forecasts, I wrote, “has raised questions about whether Netflix can grow rapidly and profitably enough to be worth anything like [its then valuation of] $145 billion.”

Of course the stay-at-home economy fashioned by the pandemic sent Netflix’s paid viewership on a moonshot, and by October 2021 had swelled its market cap to $310 billion. But as has been the case of late with many Nasdaq high-fliers, Netflix still faced the same problem: It was almost impossible to invent an earnings trajectory steep enough, from a still modest base, to forecast that Netflix stock could keep ascending in the years ahead. To make matters worse, although net earnings were growing, Netflix kept posting tiny or negative free cash flow numbers. That’s because to keep on the fast track, it had to keep lifting its cash outlays on new programming faster than it was expensing the spending as amortization on the income statement. Eventually, the heavy expenditures on movies and series needed to fall sharply as a proportion of revenues for Netflix to keep income waxing at anywhere near the pace needed to sustain anything like a $300-billion-plus market cap.

Netflix stock plummets as investors realize they’ve way overestimated its growth potential

By Q4 of last year, it was already clear that Netflix had benefited from a one-time, pandemic-driven boom that would fade fast. By mid-April, its stock had already dropped 50% from the October peak. Then came a haymaker following the market close on April 19. On its Q1 earnings report, Netflix disclosed that its customer growth rate fell by half, year over year, from 13.6% to 6.7%, and posited a drop to a paltry 5% in Q2. Net income actually dropped, shrinking by 6% as the rise in overhead, marketing, and other expenses far outpaced earnings. Margins shrank from over 27% in Q1 of 2021 to an estimated 20% in this year’s June quarter. The markets delivered one of the worst one-day blows to a major stock in recent memory, sending shares plummeting 37% to $221, and shaving $35 billion from its already-diminished valuation.

In its earnings report, Netflix gave a detailed breakdown of the reasons for the dramatic slowdown in the march of new subscribers. It admitted that the COVID boom “obscured the picture until recently,” and cited the uptake in smart TVs was more sluggish than expected, and that it is suddenly now competing with a rush of new services launched by traditional players “who see streaming as the future.”

Suddenly, Netflix looks like a “no-growth stock”

It’s hard to think of any scenario in which a stock has descended so rapidly from a super-high-flier to a near-value candidate. Its market cap is now hovering at around $95 billion. Over the past four quarters, Netflix has recorded net earnings of $5 billion, so its P/E multiple now stands at just 19.4, down from 112 in its summit last October. So Netflix is now delivering over $5 in earnings for every $100 folks and funds park in the stock (that’s the earnings yield, or inverse of the P/E). If its profits simply grow with inflation that the markets expect to drop to between 2% and 2.5% in the years ahead, investors would pocket a decent 7% to 7.5% return if its earnings don’t grow at all in real terms.

At these prices, Netflix might look like a good bet. The problem is the cash flow numbers. Its spending on new content is still pretty much erasing all of its free cash flow, leaving little or nothing for shareholders. In the past four quarters, it has spent $18 billion on new series, 18% more than in the previous 12 months. From Q1 of 2021 to Q1 of 2022, its posted a negative $42 million in free cash flow.

So on the basis that nothing’s left over after tallying the cash costs of buying and producing programs, Netflix might still be really expensive at a market cap that has dropped by 70% in the past six months. It’s the same old problem: The cash outlays are greater than what Netflix is expensing as noncash amortization, perhaps making net income look bigger than it really is. Sure, Netflix is incredibly far closer to value territory than investors may have ever anticipated. But it may have to drop even more to really get there.

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