Netflix faces a dystopian future in which hits do not guarantee growth

Netflix appeared to have the wind at its back heading into the final quarter of 2021, with the dystopian Korean drama Squid Game drawing millions of viewers and 150 original programmes ready for release, including Don’t Look Up, featuring Leonardo DiCaprio and Jennifer Lawrence.

It was, the company said, its “strongest content slate ever”. 

But the star-studded new releases were not enough to give Netflix a significant boost in subscribers in the fourth quarter. The video streaming pioneer said on Thursday that 8.3m new subscribers signed up for the service in the fourth quarter, the lowest number it had added in the period since 2017.

Worse, it forecast that it would add only 2.5m subscribers in the current quarter — down from 4m last year and well below its first quarter performance over each of the past five years. Investors dumped the stock on Friday, sending the shares down nearly 22 per cent to $397.69. They have fallen by more than 40 per cent since the height of Squid Game mania in November.

Beyond the weak guidance, the company’s performance raised bigger questions about its business model. Among them: what happens if popular new shows are not enough to lure lots of new subscribers to Netflix any more?

“Squid Game came out a week before [the fourth quarter] started, but the biggest hit of all time on Netflix was not enough to add subscribers,” said Laura Martin, an analyst at Needham & Co, who has a sell rating on the stock. “Content is no longer a competitive advantage,” especially with traditional media groups investing heavily in their own streaming services.

Netflix is expected to spend $18bn on content this year, according to Morgan Stanley estimates, as it seeks to maintain its lead against competitors including Disney Plus, AT&T’s HBO Max, Apple TV Plus, Amazon Prime, ViacomCBS’ Paramount Plus and others. The FT has estimated that eight US media companies will spend $140bn on content this year as the streaming wars intensify, and analysts expect spending to increase by double digits in the next few years.

Investors appear to be waking up to the high cost of the streaming business — and the often short shelf life of content on the services. After the Netflix report, analysts at MoffettNathanson noted that the “decay rate” of streaming content was “incredibly rapid”, especially when popular programming could be binged in a single night.

This means that “streamers have to continuously spend on new content to grab and hold new members, with any slowdown in that spend resulting in a softer quarter” for subscriber growth, the firm said in a research note.

“We question whether or not streaming is a good business,” said Michael Nathanson, an analyst at the firm. “It requires a tonne of fresh content.”

Netflix said its higher content spending compressed operating margins to 8 per cent in the fourth quarter, down 6 percentage points compared with a year earlier. Raising its margins significantly would mean spending less on content, which many see as unlikely given the intensity of competition in the streaming market.

Netflix raised its prices in the US this month to $15.50 per month from $14 — a premium to the $8 per month charged by Disney Plus. Netflix officials emphasised last week that subscriber churn had gone down in the fourth quarter, and they said plans to break even and become free cash flow positive this year were on track.

Netflix, Disney and other streaming companies racked up huge subscriber gains during the 2020 lockdowns, but a return to more normal routines has slowed growth.

The company blamed the disappointing subscriber growth in part on “macroeconomic hardship in several parts of the world”, notably Latin America. It said competition “may be affecting our marginal growth”, a rare acknowledgment that it was facing pressure from other streaming services. But it added that it continued to grow in every country in which its rivals had launched.

Reed Hastings, Netflix chief executive, said it was hard to pinpoint the cause of the slowdown because “Covid has introduced so much noise”.

But Martin said Netflix was underestimating the impact that rising competition was having on its subscription growth. “Part of the problem is that Netflix doesn’t think they have a problem,” she said. “I’ve come to the conclusion that competition is real but they haven’t come to that conclusion yet.”

She said the streaming market would become more stable once there was a period of consolidation, which she thinks would happen in three years or earlier.

“Three [streamers] have to go bankrupt and three have to survive,” she said. “And then content can become more reasonable in terms of its pricing.”

For his part, Hastings said there was no reason to question the company’s trajectory. “We’re staying calm,” he said.