Netflix (NASDAQ: NFLX) experienced low subscriber growth this past quarter and many are worried that this may not be just be a blip, but a potential sign of the company's future. Company shares traded 12% lower after the announcement that it added 5.15 million streaming users in the second quarter, a big drop from the 6.2 million estimate provided in April. Netflix added 4.47 million international and 670,000 domestic subscribers, sextupled their profits in the past year to $384 million, and saw sales rise 40% to $3.9 billion. So where's the problem?
Part of the reason that Netflix's misses hit so hard is because Wall Street sets its expectations very high. Netflix stock is extremely expensive - it trades at around $400 per share, which is about 237 times their future earnings estimates. The S&P 500 currently trades at 22 times earnings and the average media industry stock trades at around 14 times earnings. Thus, Netflix stock is way over that of the rest of the market. In its shareholder's letter, Netflix blamed the strengthening of the US dollar for its weaker-than-expected revenue internationally. They claim that they fell short of their predicted $65 million-plus revenue because of this. They wrote that, "We slowly adjust pricing over time to mitigate forex moves over the longer term, but when currency movements are rapid, they will affect our near term operating margin. We'll tend to outperform our near term operating margin targets on dollar weakness and under perform on dollar strength." In the same letter, Netflix also acknowledged rising competition from other entertainment companies as a potential factor. HBO and Disney (NYSE: DIS) are eyeing the internet entertainment services more aggressively and Amazon (NASDAQ: AMZN) and Apple (NASDAQ: AAPL) are starting to invest in more content creation projects to keep subscribers happy.
Despite strong competition, Netflix does not plan to venture off into new genres such as sports, news, or gaming. Some analysts and viewers are wondering if Netflix's fast rate of content output will result in a decrease in quality. However, it seems like critics approve of the company's shows and offerings as Netflix took the most Emmy nominations of any network this past week.
Competition is not the only problem that Netflix is facing. Their other problem is their continuing negative free cash flow. The company has been heavily investing in marketing to push their content out, spending $576.7 million this past quarter and just a bit over $1 billion in the past six months. They are simply burning through cash at this point. Netflix said that they anticipate negative free cash flows of $3 billion to $4 billion for 2018. Netflix's CFO, David Wells, commented that "We continue to see debt as the most optimal choice, the most cost-effective source of capital for the company. Obviously we'd love to get to that point where we're organically and self-funding content, and we do see a point where we can get there. But until we do, we see as debt as the right choice in terms of cost of capital." Netflix CEO Reed Hastings also insisted that there is still great potential for the company to expand internationally, especially in India where many people still watch broadcast TV.
The biggest question in investor minds right now is whether or not this is a one-quarter outlier or a foreshadowing of something worse to come. GBH Insights analyst Daniel Ives predicts that this is "more of a one-quarter issue that shouldn't bleed into the next few quarters, despite the company's conservative guidance for September."