The Real Problem With Netflix's Subscriber Growth Shortfall

Streaming large Netflix (NASDAQ:NFLX) had “a strong but not stellar” second quarter, based on the corporate’s letter to shareholders. About 5.15 million subscribers had been added globally, down barely from the identical interval final 12 months, however nonetheless an enormous quantity in absolute phrases. Relative to Netflix’s steerage calling for six.2 million new subscribers, the company fell well short.

The miss on subscribers is a minor level in my e book. What traders ought to actually be involved about is the corporate’s exploding advertising and marketing prices. Netflix not solely gained fewer subscribers than anticipated within the second quarter, however it did so whereas spending much more to lock down every of these subscribers. Customer acquisition is getting much more costly for the streaming firm, notably within the U.S.

The Netflix logo inside the company's Los Gatos headquarters.

Image supply: Netflix.

Saturation and competitors

Netflix poured $526.eight million into advertising and marketing in the course of the second quarter, about 13.5% of its whole income. That’s practically double what the corporate spent within the second quarter of 2017. Despite this heavy spending, Netflix gained barely fewer subscribers general, and much fewer within the U.S.

As just lately as 2015, Netflix needed to spend round $50 in advertising and marketing to accumulate a brand new home streaming buyer. That quantity has been rising ever since, partly the results of a shrinking pool of non-subscriber households.

The firm spent $228 million on advertising and marketing within the U.S. within the second quarter and gained simply zero.67 million new subscribers. That works out to a whopping $340 per subscriber. On a trailing-12-month foundation, which smooths issues out a bit, Netflix’s home buyer acquisition price is now above $140.

A chart showing Netflix's trailing-12-month domestic customer acquisition cost.

Data supply: Netflix. Chart by creator.

Even within the worldwide facet of the enterprise, buyer acquisition prices are rising. Netflix spent $299 million on advertising and marketing abroad within the second quarter, gaining four.47 million new worldwide subscribers. That’s round $67 per subscriber. On a trailing-12-month foundation, Netflix’s worldwide buyer acquisition price is creeping up.

A chart showing Netflix's trailing-12-month international customer acquisition cost.

Data supply: Netflix. Chart by creator.

In the U.S., Netflix could also be working out of potential clients. The firm now has round 57 million home subscribers, in comparison with round 120 million households. That suggests there’s loads of room for development, however anticipating Netflix to win over each family is overly optimistic. The quantity of competitors ensures that Netflix’s market share will stay in verify.

Netflix faces competitors from different streamers like Amazon, Hulu, YouTube, and HBO, in addition to from skinny bundles like Philo, Sling TV, and AT&T‘s new WatchTV. Those skinny bundles begin at round $15 per 30 days, and WatchTV is free for AT&T Unlimited & More subscribers. People can and do subscribe to a number of companies, however there are solely so many hours within the day to look at the onslaught of content material Netflix and its rivals are creating.

Saturation most likely is not an issue in worldwide markets, however competitors and a scarcity of latest high-profile reveals could possibly be pushing up buyer acquisition prices. The World Cup could have performed a job as nicely, with matches beginning a pair weeks earlier than the tip of Netflix’s second quarter.

Profits are taking a success

This heavy advertising and marketing spending, together with Netflix’s debt-fueled content material spree, are beginning to push down the corporate’s margins. Operating margin was 11.eight% within the second quarter, down from 12.1% within the first quarter. Netflix’s steerage requires that quantity to fall to 10.5% in third quarter.

Free money circulate stays deeply unfavorable. The firm expects a free money circulate loss between $three billion and $four billion this 12 months, a staggering quantity. Netflix plans to proceed to fund its growth with junk bonds, regardless of its inventory buying and selling for greater than 150 occasions earnings. Netflix is now paying greater than $100 million in curiosity each quarter, wiping out practically one-quarter of its working revenue.

Shares of Netflix had greater than doubled 12 months to this point previous to the second-quarter report, pushed by, so far as I can inform, euphoria. But cracks within the Netflix development story are beginning to emerge. With the price of gaining new subscribers on the rise, the trail to optimistic free money circulate is beginning to look much more arduous to me.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of administrators. Timothy Green has no place in any of the shares talked about. The Motley Fool owns shares of and recommends Amazon and Netflix. The Motley Fool has a disclosure policy.

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