Shares in Netflix fell sharply after the company’s third quarter earnings report showed it added fewer new subscribers to its base than analysts predicted.

The consumer video streaming service reported 2.2 million net new subscribers in the July to September quarter. Analyst expectations were pitched at around 3.3 million net adds, and Netflix even missed its own sober 2.5 million net new subscribers forecast, made three months ago.

Third quarter earnings per share of $1.74 also missed $2.13 targets although headline revenue of $6.44 billion bested the market’s $6.39 billion projection.

But it was the new user numbers that sent the stock price tumbling nearly 6% in after-hours trading, implying a $495.40 share price versus the previous $525.42 level.

MARKET ONLY HAS EYES FOR SUBS

The response of investors is not really surprising; the rate of new subscriber growth is the one figure the market studies above anything else.

Never mind that more than 10 million subscribers joined Netflix during the second quarter, and nearly 16 million paying users were brought on during the first three months.

These were unexpectedly bumper numbers boosted by millions of people being locked down at home during the worst of Covid, and have fuelled an otherwise stonking 2020 for the stock, rallying about 50% year-to-date even after the post-trading slide.

Yet concentrating on these 90-day measures misses the point. There are more important long-run issues facing the company, not least ongoing expansion overseas when some claim it has largely hit saturation point at home in the US.

Cash flow also remains an issue despite a much improved showing so far this year, largely thanks to pandemic production shutdowns.

Free cash flow was positive for the third straight quarter, adding up to $2.2 billion positive free cash flow for the first nine months of 2020.

Cash burn is set to return as production schedules ramp back up, with Netflix admitting that it expects to be slightly negative on free cash flow in the last quarter of 2020, and flagged up to $1 billion of cash burn anticipated for 2021.

SOLVING THE USAGE PRICING PROBLEM

The other big issue is pricing. Netflix has limited upsell options beyond adding incremental upgrades to add extra devices to accounts, or pushing through subscription price hikes.

Netflix has to rely on new subscribers to fuel almost all of its growth. Imagine how different 2020 might have been if Netflix had been able to charge based on usage levels. It would have made hay this year when there was precious little for millions of us to do but watch the telly.

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Issue Date: 21 Oct 2020