Netflix tumbles after sharply missing subscriber estimates

Emily McCormick breaks down Netflix’s first-quarter results, which topped analysts but missed on subscriber additions. BofA Global Research senior internet and digital media analyst Nat Schindler, discusses his analysis of the quarter, including why the firm thinks the company “is in a strong position to continue price increases in 2021.”

Video transcript

JULIE HYMAN: We do begin this morning with the big stock story. And that, of course, is Netflix. The company's subscriber growth coming in way below what analysts had anticipated. Not only that, its forecast for this quarter's subscriber growth is below estimates.

Our Emily McCormick has been tracking all of the numbers. Emily, what are some of the highlights here? What stands out as the most important numbers to know when it comes to Netflix?

EMILY MCCORMICK: Well, Julie, as you mentioned, all eyes were on those subscriber numbers. And first-quarter subscriber growth sharply missed expectations, even as we saw Netflix's revenue and earnings top estimates. Remember that both Netflix and Wall Street had already been expecting to see some payback in subscriber additions after last year's record jump in growth during the pandemic. But what Netflix delivered was even slower than these already tempered expectations.

Now specifically, first-quarter net paid subscribers rose by just 3.98 million. That was well below the about 6.3 million that had been expected. And Netflix had added a quarterly record of 15.8 million subscribers in the same three months of last year.

Now, second-quarter guidance was also a big disappointment. So the slowing momentum's set to continue. Netflix sees just 1 million new subscribers coming on in the current quarter. And that compares to estimates for 4.4 million.

Now, altogether Netflix ended the quarter with about 208 million global subscribers. So it still is leading the pack there and leading the competition. But other companies, like Disney especially, are catching up. Disney+ had 100 million subscribers as of early March, and that was within a year and a half of launch. And not to mention the other streaming competitors now in the industry.

Now, I was taking a look at some analysts notes this morning, and they seemed a bit more forgiving of Netflix subscriber miss than many traders of the stock seem to be this morning, with that stock down about 8%. For example, Aaron Kessler of Raymond James said that the miss on subscriber additions was more a function of lower acquisition rather than retention given the subscriber term trends were actually quite strong during the quarter. And Daniel Salmon of BMO Capital Markets said he continues to recommend shares of Netflix since its, quote, now passing its primary 2021 bear point, making this a particularly attractive buying opportunity. But altogether again, Julie, seeing that stock under a lot of pressure this morning because of that subscriber miss.

JULIE HYMAN: Thanks Emily. Let's talk to one of those analysts now who is saying maybe things aren't going to be so bad for Netflix, especially over the longer-term. Nat Schindler is joining us. He's the Senior Internet and Digital Media Analyst at Bank of America Global Research. Nat, welcome.

First of all, before we sort of dig into your thesis on Netflix, it's always fascinating to me when we get a miss like this, and a miss that seems not only to have surprised the analyst community-- and I'm talking specifically about the subscriber numbers-- but seems to have surprised the company itself. What do you think happened here in the quarter that caught-- that created this gap in perception?

NAT SCHINDLER: Well, I think there's some specific things to this quarter and because of the pandemic that have really changed their ability to predict. But I think this is also a problem with-- something that Netflix has saddled themselves with. People aren't talking about the fact that they beat revenue. People aren't talking about the fact that they crushed EPS estimates. People are talking about the fact that they missed net subscriber additions in the quarter over last quarter-- not year-over-year growth, not even total subscribers, which was off by less than 1%.

So this is really a tertiary metric, and it makes it extremely volatile. It's incredibly difficult to predict what's going to happen in a given quarter. So this quarter in particular, things did happen that made it very difficult to predict. As you mentioned earlier, they had a huge year last year and pulled in a lot of growth that they probably would have gotten in this year.

On top of that, they had to slow down production. So tentpole titles like "The Witcher" and "Money Heist" and others-- which would be real draws for gross subscriber additions, those new people coming into the system-- got pushed off to later in the year from earlier. They would have been out in the first half of this year.

So in a sense, this shouldn't really be a giant surprise. It's a surprise in any quarter when it happens. But it's not a surprise that it does happen, because these are very hard to predict. And coming off a pandemic, Netflix's net subscriber additions are going to be much harder to predict.

And you're also going to see that probably across a lot of other companies. I think that people should see this as a warning, that things were very difficult to predict last year when we were going into lockdown. That doesn't mean, as we come into this year and things begin to open up, that they'll be easy to predict. They actually might be even harder.

So I look at this as a buying opportunity, largely because if you look at what has happened in the past and the times that Netflix has missed in the past on this really hard to predict number, net subscriber additions-- and that's what the street focused on-- the stock has rebounded immensely. Up actually in the last five times this has occurred over the last five years, the stock is up 78% within a year from the close the day after missing. So we see this is something that, really, fundamentally, nothing has changed.

MYLES UDLAND: Hey, Nat. It's Myles here. I'm just curious, how do you think about some of the company's commentary around the slate in the first quarter and how much it thinks having more new content come on the platform can drive growth in the second half, and how you're kind of squaring that framework from Ted and Reed with these longer-term drivers that you're also talking about?

NAT SCHINDLER: Well, there seems to be-- they have said in the past that individual titles are not real drivers of growth. And then this quarter, they are really saying that, look, we didn't have some of the most important titles we expected. So there seems to be a bit of a contradiction.

But on the other side of the coin, you can see what occurs. When people are talking about Netflix at the water cooler, which they can't do now, or walking down the street with their friends, which they might, it brings people in. And that happens really around these giant tentpole, or as Ted Sarandos likes to say, zeitgeist, titles. And that brings in the gross subscriber additions.

But if you want to be positive, even without those tentpole titles, churn was at very low levels, lower than last year, and then even returned just after a price increase to low levels quicker than ever. So engagement and churn shows you that current subscribers like it, and they're staying around. It's just they need something to push them over the edge to get that next group.

BRIAN SOZZI: What would quantify as a fundamental change in the business? Because I think some investors would look at this quarter and say, folks are starting to go back out into the wild after getting that vaccine, and perhaps engaging with the platform less, perhaps maybe even canceling. Although of course, not any large numbers. But why is that not a fundamental change?

NAT SCHINDLER: Well, I mean, that could be a fundamental change, if you saw it in churn. You didn't. And we have our own data for churn, at least in parts of the world. And management was very clear that overall, it did not occur in churn across the world. And it could be a problem if you saw engagement fall, which again, didn't happen.

So people are still watching Netflix. They're watching Netflix more and more every year. I think that they're overplaying on the investor side and on the media side that the worry is coming that, oh, there's new competition coming. There's always been competition. And that competition was linear television.

But what's happening is, despite a miss here, people are still watching more Netflix. And they're probably cutting-- even going back out into the world with a pandemic, they're watching more Netflix. So that tells me they're probably cutting into normal television.

JULIE HYMAN: And Nat, we also have to remember, of course, that the growth is international. We look through it of the US prism quite frequently, and reopening here. But around the globe is where the growth is coming. Finally though, I want to circle back to something you said at the beginning, which is that they have this incredibly lumpy subscriber growth. And that's what investors have paid attention to.

But the revenue and earnings beat estimates. And that's especially impressive, perhaps because, as I've been talking about, Netflix has finally sort of turned the corner on its cash burn problem. It seems to have. So how did it achieve that earnings per share and revenue growth numbers? Is it because of the increase in prices? What was the real driver there?

NAT SCHINDLER: Well, prices were an increase that helped on revenue growth. That's been a very consistent theme. They have said that they expect mid-single digit CAGR on pricing ad infinitum. And they've been going quite a bit faster than that in general. Obviously, it differs slightly as you go around the world. But certainly, as you look at the more penetrated geographies, we're seeing quite a bit better than that.

What's driving the profitability, though-- and obviously, revenue came in just fine, but profitability was even better. Part of that is this content problem. So they cannot start amortizing their content costs until the shows are available on the network for consumers to see. So shows that they thought would be hitting in Q1 are hitting in Q3 or Q4, which means that their costs are going to go up, and their margins will fall in the second half. Overall, their margins are increasing very rapidly, and they're still predicting 20% operating margins for the year. Now, they were much higher than that this quarter due to that timing issue.

JULIE HYMAN: So we'll see how that plays out through the rest of the year. But a good thing to keep an eye on, that those margins will be perhaps a little bit more cramped. Nat, thank you for being here. Nat Schindler is a Senior Internet and Digital Media Analyst at Bank of America Global Research.