Netflix’s dismal results are more evidence that the pandemic trade is over

After you pull growth forward, the afterparty is more like a hangover

TechCrunch got its teeth into the pandemic trade and its possible conclusion yesterday. As a refresher: After the initial onset of COVID-19 and the ensuing lockdowns, changes to work environments and restriction of travel, some companies saw their values quickly appreciate as they found investor favor.

The reasons for some sectors gaining luster in the eyes of the investing class were manifold, but can be condensed. Companies and sectors that saw demand accelerated by the pandemic saw their share prices similarly improve. And software companies, which showed resilience thanks to customers not being able to operate without paying for their offerings, quickly appreciated, pushing their valuations higher and higher.

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Until the trade ended. Software companies began to shed their pandemic valuation gains in the final weeks of 2021 and have continued to do so in the new year. For companies like Peloton, which rode a consumer demand shift that gave their products more shine, the trade is coming apart a little bit later.

Netflix is the latest company to suffer. Recent earnings results were just short of a catastrophe for the U.S. streaming company. Its shares are off around 22% this morning, bringing its value down to around $174 billion from a peak of more than $300 billion set last November.

As a pandemic trade, Netflix was an obvious contender; it provides inexpensive at-home entertainment. And when everyone stayed home, well, Netflix did quite well.

But that accelerated period of growth has ended. Netflix’s latest earnings report shows that instead of the company enjoying an expanded total market for its services that earlier, faster growth might have hinted at, it may have instead taken future growth and moved it up, leaving the popular video service now in low-growth quicksand, with investor expectations above what it can deliver.

Today, we’re exploring whether international growth can replace lost domestic growth at the company, and what could be ahead for firms like Netflix that find themselves coming down from a period of elevated investor attention and consumer demand. Netflix is an example, but what the company is going through could be an indicator of what’s ahead for other consumer services that had a strong period of growth amid the pandemic. Who else is in danger?

Understanding Netflix’s results

Netflix gained 8.3 million new paid subscriptions in Q4 2021, finishing the year with 222 million paid memberships. That doesn’t sound bad out of context, but context matters. First, the company projection was 8.5 million, not 8.3 – and markets are never fond of missed forecasts. Second, the 222 million figure means this was its lowest year of subscriber growth since 2015.

Taking a step back, this isn’t so much about missing the mark as it is about trust in numbers. Is Netflix capable of interpreting its situation correctly? And of forecasting accurately? Needing to address this may also explain why the company is more conservative in its Q1 2022 forecast. For the current quarter, it only expects 2.5 million new paid subscriptions, compared to 4 million in Q1 2021 – when, by the way, it expected 6 million.

But even if the company is adjusting its guidance, it still leaves questions about what is going on. For instance, media experts may wonder if the company is affected by increased competition or merely reaching saturation levels. Netflix dismisses the importance of these concerns, and we tend to agree. It isn’t necessarily good news, though.

Is the slowdown a shock?

If you rewind the clock to April 2021, or about three quarters ago, Netflix told investors that it was seeing some growth slow after a period in which it saw customer adds temporally moved forward:

We believe paid membership growth slowed due to the big Covid-19 pull forward in 2020 and a lighter content slate in the first half of this year, due to Covid-19 production delays. We continue to anticipate a strong second half with the return of new seasons of some of our biggest hits and an exciting film lineup. In the short term, there is some uncertainty from Covid-19; in the long term, the rise of streaming to replace linear TV around the world is the clear trend in entertainment.

The company was half right, in other words. Yes, it did see growth pulled forward, but strong growth in the second half of 2021 did not materialize.

A good question at this juncture is what the company is able to do moving forward.  The Exchange is curious whether international growth can replace lost domestic growth. If so, there could be a path out of the woods for Netflix. If not, the company may better resemble a cult-hit show on its platform just concluding its second season: headed for the chopping block.

Can global demand replace domestic demand?

One data point in particular caught our attention in Netflix’s letter to its shareholders: That “more than 90%” of its paid net adds in 2021 came from outside the U.S. and Canada, which it groups under the “UCAN” designation.

Zooming in on Q4 2021, most of Netflix’s paid net adds came from the EMEA region (3.54 million), followed by APAC (2.6 million). With a 1.2 million total, UCAN only accounted for more new subscriptions than Latin America, a region that Netflix describes as undergoing “macro-economic hardship” in the pandemic’s aftermath.

However, the respective importance of global regions for Netflix can’t be measured only in terms of new subscriptions. The overall number of subscribers matters, too, as does, perhaps even more importantly, their average revenue per membership.

It is in the U.S. and Canada that Netflix earns the most per subscription –$14.78 in 2021’s last quarter. This will likely increase, as the company announced a price hike in these two countries. In contrast, Netflix lowered its rates in India in December 2021, despite how low they already were compared to other markets.

In a video interview, key executives from Netflix expressed confidence in India’s long-term prospects. Expanding into Brazil and Japan hadn’t been easy either, they recall. “Our goal is to maximize long-term revenue in each of our markets.” That sounds like a recipe for lower prices to drive more subscriber growth, followed by the sort of price increases that we’ve seen in the UCAN markets. But it’s a strategy that involves patience and a willingness to think long-term. Will shareholders be as patient as Netflix hopes?

So what?

Because the private markets are opaque, we often try to use the public markets as a sort of oracle; what happens to companies that do disclose lots of information is sometimes helpful to understand what is happening among startups. The cases of Netflix, Peloton and other recent declines are useful from a few perspectives:

  • In a narrow sense, there was a boom in exercise-related startups; those could be entering a winter cycle if the pandemic trade’s unwinding plays out for them in a manner that is similar to what has happened to Peloton and Netflix.
  • In a broader sense, services that enjoyed strong consumer demand could not only have pulled growth forward, but could find themselves, like Netflix, dealing with lower demand today than they did pre-pandemic. For startups, this is a warning sign that what once was may not be again.

It’s all bad news, in other words, unless you are building an upstart tech company in an area that was harmed by the pandemic – and managed to survive a multiyear downturn, we suppose. But that’s not most startups, and that situation doesn’t apply to most founders. In terms of warning signs, here’s a big one for a host of startups.