By Jon Swartz and Jeremy C. Owens
Netflix Inc. reported a dramatic slowdown in new subscribers Tuesday and widely missed earnings expectations, sending shares on a plunge in after-hours trading.
Netflix /zigman2/quotes/202353025/composite NFLX +1.38% reported 2.2 million net new subscribers in its third quarter, after two consecutive quarters topping the 10 million mark amid shelter-in-place orders related to the COVID-19 pandemic. The No. 1 streaming service reported net earnings of $790 million, or $1.74 a share, compared with net income of $1.47 a share in the year-ago quarter. Revenue improved to $6.44 billion from $5.25 billion a year ago. Analysts surveyed by FactSet had expected adjusted earnings of $2.13 a share on sales of $6.39 billion.
Netflix warned in July that the subscriber gains it experienced in the first half of the year would likely lead to a deceleration in the second half, guiding for 2.5 million new subscribers in the third quarter. Investors sold off the stock in response, sending shares down 6.5% the next day.
Netflix forecast 6 million new subscribers in the fourth quarter, which came up short of analysts’ average expectations of 6.56 million, according to FactSet. Shares fell about 5% Tuesday in after-hours action and were down as much premarket Wednesday.
“The state of the pandemic and its impact continues to make projections very uncertain, but as the world hopefully recovers in 2021, we would expect that our growth will revert back to levels similar to pre-COVID,” company executives said in a letter to shareholders . “In turn, we expect paid net adds are likely to be down year-over-year in the first half of 2021 as compared to the big spike in paid net adds we experienced in the first half of 2020.”
Netflix has largely benefited from Americans forced to stay at home for months because of the pandemic. But as some states loosen quarantine restrictions, Netflix’s U.S. subscriber growth “is reaching saturation,” eMarketer analyst Ross Benes said. “However,” he added, “Netflix has tremendous upside internationally and we expect significant subscriber additions abroad.”
As Europe and perhaps U.S. states impose lockdowns during the latest wave of COVID-19 cases, Netflix could benefit with more viewers at home — especially amid a precipitous drop in ratings for pro sporting events, and the continuing decline of movie theaters. Netflix is also facing furious competition from Apple Inc. /zigman2/quotes/202934861/composite AAPL +1.98% , Walt Disney Co. /zigman2/quotes/203410047/composite DIS -2.60% , Comcast Corp. /zigman2/quotes/209472081/composite CMCSA +2.25% , AT&T Inc. /zigman2/quotes/203165245/composite T +0.09% , Amazon.com Inc. /zigman2/quotes/210331248/composite AMZN +1.94% , and others that are trying to catch up in streaming.
Netflix has enjoyed an advantage on those newer rivals because of the developed pipeline it had for content, which meant it had plenty of new shows and movies already in the can when COVID-19 forced production of new content to halt. Executives attempted to ameliorate concerns about the pipeline in the second half of the year and into 2021 on Tuesday by revealing that shooting has resumed for high-profile content including the fourth season of “Stranger Things” and the second season of “The Witcher.”
“For our 2021 slate, we continue to expect the number of Netflix originals launched on our service to be up year-over-year in each quarter of 2021 and we’re confident that we’ll have an exciting range of programming for our members, particularly relative to other entertainment service options,” executives said in their letter to shareholders.
During a videoconference call late Tuesday, company co-Chief Executive Officer Ted Sarandos said Netflix was on pace to complete 150 productions throughout the world by the end of the year.
“Content is king in the media world and Netflix’s backlog of new content seems to be slowing down, along with the attention span and Netflix fatigue of home viewers,” Wendy Johansson, vice president of experience at digital consultancy Publicis Sapient, told MarketWatch. “With the competition from the big studio networks owning their own streaming services, it won’t be easy to bring new engaging content forward without global economies opening up to allow for new content creation.”
The production slowdown actually helped Netflix’s cash flow, however, as it continued to rake in subscription fees while not realizing costs for making new content. Netflix reported free cash flow of $1.1 billion in the third quarter, after losing more than $550 million by that metric in the same quarter a year ago.
“For the full year 2020, we forecast [free cash flow] to be approximately $2 billion, up from our prior expectation of break-even to positive,” executives disclosed. “This change is due primarily to our higher operating margin expectation for 2020 and the timing of cash spending on content.”
“The fresh cash flow is an exciting one for us,” Chief Financial Officer Spence Neumann said on the videoconference. “You can trust that we are going to remain disciplined, and maximize long-term shareholder value.”
The company’s improved free cash flow “continues to dramatically improve, an overlooked long-term positive for the stock,” Jefferies analyst Alex Giaimo said in a note Tuesday. Netflix’s $1.1 billion in Q3 came in well ahead of street expectations of $241 million, he wrote.
With subscriptions slowing down, analysts have suggested that Netflix could raise prices, pointing to recent moves to shore up its financials. This month, Netflix stopped offering free trials in the U.S. and raised HD subscription rates in Canada, leading to speculation that it might follow suit in the U.S.
Read more: Is Netflix about to raise prices in U.S.? Recent actions suggest it could happen
The company had no comment on potential higher prices in the days leading to its results — Chief Operating Officer Greg Peters declined comment during Tuesday’s videoconference — but some of its nearly 200 million subscribers seem open to the idea, according to one Wall Street firm.
In a poll of 2,500 U.S. consumers in the third quarter, 53% said they would be willing to pay more, up from 48% in the fourth quarter of 2019, Cowen analyst John Blackledge said in a note Oct. 14. He has an outperform rating on the stock with a price target of $625.