In the first quarter of this year, the streaming service Netflix lost almost 2 million users, because it refused to serve Russian subscribers, and increased prices for American ones.

What happened

Shares of the streaming platform Netflix plunged 25% on the Nasdaq postmarket on April 19. Quotes have fallen from $348 to $258, the lowest since December 2018. This is how the papers reacted to the company’s report for the first quarter.

Despite the fact that the indicator of earnings per share (EPS) was higher than the consensus forecasts of analysts ($3.53 vs. $2.95), the service’s revenue ($7.8 billion) fell short of market expectations ($7.9 billion). In addition, the number of subscribers to the service has declined for the first time since 2011. The company’s operating profit remained virtually unchanged at almost $2 billion, while net income fell 6% to $1.6 billion.

Following Netflix’s disappointing report, other streaming service companies also tumbled. Disney was down 5% postmarket, Roku – 6%, Warner Bros. Discovery (owns HBO Max) – 4%, Paramount – 6%.

Subscribers leave

The net decrease in the number of subscribers for the quarter was 200,000 people, despite the fact that the company had previously forecast an increase of 2.5 million. Due to the termination of work in Russia, Netflix lost 700,000 paying subscribers. The company also saw a slowdown in business growth in Central and Eastern Europe in early March. The company lost another 600,000 subscribers in the US and Canada due to price increases. Now the service has 222 million subscribers.

Earlier, the Russian authorities tried to oblige Netflix to include 20 mandatory Russian TV channels in its broadcast schedule. However, the company refused to do so, and then suspended work in Russia in protest against the war in Ukraine.

In its letter to investors, Netflix said it would not grow «as fast as we would like» in the near term. The slowdown in service growth is due to four factors: firstly, the company cannot control how many households with a home Internet connection use the TV (and Netflix users tend to prefer to watch TV shows on them), and secondly, many exchange  passwords from personal accounts. The scale of this practice is huge – with 222 million paid users, another 100 million use other people’s passwords.

Among growth concerns, Netflix also cited competition from other streaming services (HBO, Apple, Amazon and Disney are developing their streaming platforms), as well as macroeconomic factors: rising inflation, slowing economic growth, geopolitical events, as well as some of the ongoing negative effects of COVID-19.

Course for advertising

Netflix predicts that it will drop another 2 million customers in the second quarter. To keep growing, the company will consider creating a cheaper subscription plan with ads over the next few years.

In general, the business model of a cheaper subscription but with ads has proven to be viable, with Comcast-owned streaming service Peacock using it, for example, and Disney+ recently announced plans to introduce an ad-supported subscription option.

For investors

It is risky to take a long position on Netflix right now, as the decline could continue in the absence of positive drivers, but they are «good for speculation». 

The company has a strong position in the streaming market. Netflix is ​​on a positive free cash flow trajectory. And this means that there is a possibility of launching a share buyback program. In Q1, Netflix’s free cash flow was $802 million (+15% yoy), and the company expects this figure to be positive throughout the year.

The introduction of cheaper ad-based rates should accelerate audience growth, especially in emerging markets, and improve content monetization.

The value of the shares and the valuation of the company by multiples were greatly inflated. It is not worth buying shares right now, on a drawdown, but it is better to wait a while. Shares will remain under pressure in the next few months. Market conditions and the state of the company itself do not speak in favor of the purchase.  An alternative for an investor could be Disney papers, which so far has recorded a good growth in subscribers of the Disney + service and «steps on Netflix’s toes».