Netflix‘s (NFLX) second-quarter earnings release earlier this week, sent the stock down by double digits. While the company handily topped profit forecasts, its stock was unable to withstand the fact that the company’s subscriber growth is not keeping up with expectations. Many in Wall Street now believe the video-streaming service may have reached a saturation point after what has been nothing short of unstoppable growth in its subscriber base.
In a report released Monday, Netflix said that it had failed to attract the numbers it had predicted, as it fell short of its target of 2.5 million for the second quarter by a whopping 800.000 subs. The company also said that it had hoped to add 500,000 new subscribers in the US. Instead, it managed an increase of only 160,000 subs. The growth in subscribers was also down substantially on a year-over-year basis, when the company added a net 3.2 million subscribers in Q215. Netflix executives blamed what they called a ‘bumpy ride in an attempt to disrupt a big market.’
“We are growing, but not as fast as we would like or have been,” the company said in its letter to shareholders Monday. “Disrupting a big market can be bumpy, but the opportunity ahead is as big as ever and we continue to improve every aspect of our business.”
Many analysts feel that Netflix is not only struggling to find a solid footing in China, but the company is also approaching a saturation point in terms of its subscriber base both at home and abroad. The question that persists now is what NFLX holders will do when that happens. Yet, and interestingly enough, while some investors are dumping their Netflix holdings with the believe that the best days of the name are behind it as growth slows, others are hitting bids to long the stock. In fact, recent short interest data for the 6/30/2016 settlement date shows a significant decrease in short interest for shares of Netflix. As of June 30, the short interest for the company totaled 33.9 million shares, as compared to 36.3 million shares since June 15, a decline of 7 percent.
Netflix Has Successfully Raised its Prices
Every time a company has attempted to raise its prices, consumers have reacted negatively. Often the backlash can be so damaging that the company struggles to regain its footing in terms of revenue and gaining back its business. Yet, Netflix was able to raise its prices by 4% without getting significantly affected. In fact, instead of losses, the company recorded an increase in profits even though 2% of its subscribers canceled their subscription. While the churn rate (rate of loss of subscribers) may have been higher than Netflix initially predicted, the company still managed in the second-quarter, which is historically weak for the company, to earn $0.09 per share, well above the $0.02 per share analysts were expecting. Revenues also came in higher, rising 19.5% from a year earlier.
“People don’t like price increases, we know that. It’s a necessary phase for us to get through,” Netflix CEO Reed Hastings was quoted as saying during a conference call. “With the increased revenue we’re continuing to invest in better and better content, so that’s what makes us feel very strong and positive about the long term and that this is a short term phenomenon.”
Netflix’s Long-term Success Still Possible
A considerable number of subscribers canceled their subscriptions after Netflix increased the price for its standard HD service for those previously paying $7.99 monthly by $2, to $9.99 per month. But even with the price increase, the Netflix story remains on the positive side of things. In fact, analysts think the company’s long-term goals may be doable. Let’s not forget the shift in video entertainment is still underway and Netflix remains the market leader in the space. The fact that the company bagged a number of Emmy nominations, is a clear indicator that it is taking over from the traditional TV platforms that people have known for years. Moreover, with its original content and programming getting better, subscribers will be even more willing to stick with a well-known service that keeps producing high quality material.
Keep in mind, Netflix ended the first quarter of 2016 with 81.5 million streaming subscribers. The company currently has 83.1 million subscribers worldwide. That’s growth right there. These factors, along with the company’s strong fundamentals-1.85%,3.32% profit and operating margin, respectively, and the fact that Netflix’s international expansion is still in its infancy, should positively affect the firm’s bottom-line and as a result the stock’s price-per-share. Now, I am not saying that valuation issues don’t exist with the equity, or that investor sentiment does not count. After all, the name trades with a forward P/E of well over 84 and the company expects to break-even on net income this fiscal year. That said however, Netflix stock, which was the top performer in the S&P 500 last year, has lost closed to 35 percent from its peak at the end of last year. At the very least, a $95 price target by end of this fiscal year seems reasonably and objectively doable.