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18 July 2019

Netflix bats away ad assertions as domestics subs base hurt

“When you read speculation that we are moving into selling advertising, be confident that this is false,” reads a line buried within Netflix’s second quarter letter to investors, as the SVoD frontrunner sought to defend its current business model following recent rumors and below expected subscriber additions.

Despite this strong statement, emphasizing how the company believes it will draw more value in the long term by staying out of competing for ad revenues, the criticism against Netflix this week has been familiarly unrelenting. The industry really, really wants Netflix to embrace ads and people would live to regret it – and with all the criticism it’s easy to brush over the fact Netflix has just blossomed into a $5 billion quarterly revenue business and rising.

Criticism has been targeted mainly at domestic subscriber uptake, losing ground for the first time since 2011 as net losses came in at 126,000 subscribers in the US, dropping to 60.1 million. No doubt this is a significant setback for Netflix, but we fully expect the company to recover in style as 2019 progresses and there was a gentle reminder from Netflix that it currently only earns approximately 10% of consumers’ viewing time, and even less of mobile screen time, so there is substantial room left for growth.

Even without the domestic dent, total subscriber gains worldwide were well below expectations, with 2.7 million additions in Q2 compared to the 5 million projected. Naturally, price hikes were to blame, and CEO Reed Hastings also cited a lack of original content to attract new subscribers – which is a little surprising considering Netflix’s wealth of original content. But we feel this only emphasizes the company’s lofty content ambitions.

That said, streaming content obligations decreased 2% sequentially in the quarter, which reflects the company’s shift towards more owned content over licensed content – over 6 years since Netflix first got into original programming.

This drive was based on the premise that the license program would be more and more difficult to come by and that sources of content to license be under different levels of strain. Chief Content Officer Ted Sarandos reckons this has paid off, saying this week, “It’s been very important to the business to continue pushing down that road for more international, more global, more original film. We also have a large investment coming up in animation that will serve us to see some of the fruits from early next year. So, we think we’re betting in all the areas of content that our consumers love.”

International subscriber growth also slowed as Netflix picked up 2.8 million net memberships, growing to nearly 91.5 million. This was also criticized, yet when you look at the bigger picture, Netflix has actually amassed more new international subscribers in the six months ended June 2019 (10.7 million) compared with the six months ended June 2018 (10.56 million) – so haters shouldn’t be so hasty.

As we mentioned, revenue is poised to surpass $5 billion, surging 26% in Q2 to $4.92 billion and this is forecast to reach $5.2 billion next quarter.

Netflix has projected 7 million global subscriber additions for Q3 (0.8 million domestic and 6.2 million international) which we suspect has been approached more cautiously than the previous forecast. But while the entry of Disney, Apple, WarnerMedia, NBCU and more into the streaming scene over the next 12 months would appear to be detrimental to Netflix and could knock its domestic subscriber base further – the company is relishing the prospect of enhanced competition.

Although you wouldn’t know it going by the majority of headlines, Netflix has achieved something spectacular and historic by reaching 150 million subscribers. For context, Verizon has about 158 million wireless subscribers, albeit all in the US while Netflix is global, but the comparative ages of the two companies – 22 and 35 respectively – as well as the gap in infrastructure and assets – speaks volumes.