The sharp decline in the Netflix share price in after-hours trading last night appears to be a knee-jerk reaction to disappointment over the number of new customers in Q3, and its Q4 guidance.
Netflix share price drops despite record revenue
While it’s certainly disappointing that Netflix only gained 2.2m new subscribers in Q3, the lowest since early 2016, it’s only a concern if you take it in isolation. Record revenues of $6.44bn suggests there is still plenty of fuel in the tank. However, this drop in new subscribers seems to have caused the Netflix share price to fall sharply opening below $500 post announcement.
When Netflix management lowered their expectations for Q3 new subscribers in July to 2.5m, they must have felt that after two record quarters, that there was likely to be a pause as economies reopened and live sport started to be shown on TV again.
This caution turned out to be well founded. As a reminder, in Q1 and Q2 Netflix added 25.8m new subscribers, almost as many as in the whole of 2019, when it added 27.8m. First-half revenues came in at $11.92bn, though profits did fall short due to a one-off charge.
Cautious guidance proves sensible
As a result of this huge growth in subscriber numbers management sensibly took the option to be cautious about their guidance for Q3, largely due to concerns about new subscribers in the upcoming quarter coming up short due to pull forward effects starting to wane, as lockdown measures started to get eased in the summer months, while the return of live sport on television also diluted the numbers.
Estimates for new subscribers in Q3 were set very low at 2.5m new subscribers, well below expectations of 5.3m. Revenue estimates on the other hand were set at a record $6.33bn, and as highlighted earlier these came in higher, beating analyst expectations.
None of this changes the fact that Netflix has added more new subscribers in the first three quarters of 2020 than it did in the whole of 2019, and while the pandemic has certainly played its part in that, it has still done this despite the new challenges of Apple TV+, Disney+ as well as its other closest competitor Amazon Prime.
It is very conceivable that Netflix will struggle to add subscribers at the rate we saw in the first two quarters of this year, however it still remains in pole position when it comes to the quality of its content, and while there are concerns about saturation in its US market, where it only added 180k new subscribers, that’s not where the real growth opportunities lie.
Netflix still leading the market
Netflix is still the market leader in the sector, and it also leads the way in non-English content which also sets it apart from its peers internationally. The continued closure of cinemas until early next year is also likely to keep these subscriber numbers fairly buoyant.
For Q4 Netflix has said it expects revenues to come in at $6.57bn, while adding another 6m new subscribers, both of which were below what investors had been hoping for, and with the shares close to record highs there is perhaps an element of caution among some investors that the Netflix momentum may start to struggle as Apple and Disney start to get their act together in what is a highly competitive market.
This is undoubtedly a concern going forward, however Netflix still has the option to nudge its prices up, given the quality of its content, something it has already done in Canada this year.
Disney and Apple still have some way to go and there is a reason their content is cheaper. It’s much more limited, and both will have to spend a lot more money in the longer term to move people away from Netflix, which has a much bigger library for all tastes.
Netflix still has a strong content slate including season three of Star Trek Discovery, and season four of The Crown, while production is starting on the next season of Stranger Things, which should land next year.