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Netflix tumbles on dark outlook; ASML still sees strong demand
Peter Garnry
Chief Investment Strategist
Summary: Netflix's decade of uninterrupted growth came to a halt in Q1 as the company lost 200K subscribers and to make things worse Netflix is estimating to loss another 2mn paying subscribers in Q2 as competition is heating up and inflation is potentially putting pressure on households to cut down on less essential things. We take a look at the four drivers that Netflix can tap into to get back on the growth track. In today's equity update we also take a look at ASML earnings which are showing investors that demand is still very strong for semiconductors but the risks in the industry has gone up dramatically because of the war in Ukraine.
Netflix shares tumble 26% on Q2 outlook
Netflix has been this unstoppable growth train for over a decade but that ended in Q1 2022 with the video streaming company losing 200K paying subscribers (the chart below does not include the Q1 2022 figure). Even if we factor out the 700K loss from Russia it was a big miss against its own guidance of adding 2.5mn. In addition, Netflix is guiding a loss of 2mn paying subscribers in Q2 vs estimates of +2.5mn. The market got spooked sending Netflix shares down 26% in extended trading and to levels 65% below the recent all-time high back in late 2021.
What does that tell us about Netflix and sell-side analysts? It says that both analysts and the company itself have difficulties understanding the post-pandemic demand picture and especially the competitive landscape that is changing with e-sports and gaming, but also the impact from higher inflation. While some households can substitute into lower priced consumer goods when facing inflation the video streaming services are all priced at the same level and are offering the same product, so substitution does not happen. Cancellation is more likely the outcome of inflation.
So what are the drivers that can pull Netflix back to an interesting growth trajectory?
- Advertising models. Netflix could adopt a three-layered pricing model with a free advertising model as the entry followed by an advertising model with less advertisement but a small monthly payment, and finally the advertising-free model with the most expensive subscription. This could widen the distribution and extract more revenue from their global customer base.
- Limiting password sharing. Netflix has a big issue involving password sharing with some estimates suggesting a 3-to-1 factor of logins from non-paying users that have lent a password to those that pay. Making this practice harder could regain some revenue growth.
- E-sport and gaming. With almost a quarter of a billion paying customers Netflix could do more to harness its distribution. The company has previously said that its biggest competition threat is from e-sports and gaming. If Netflix sees itself as an entertainment company rather than a video streaming service making movies and series, then it could aggressively branch into e-sport streaming and even gaming on the platform.
- Improve hit-making. While Netflix did not touch on this issue, the fact is that over the previous year the quality of Netflix productions has deteriorated and the company has not been producing enough hits which is dangerous longer term and must be changed.
ASML Q1 result calms investors
The semiconductor industry has had a tough 2022 with our semiconductors theme basket down 24% this year and down 9% alone this month. Rising interest rates have impacted lofty equity valuations and the war in Ukraine has caused a major operational risk to the industry as the majority of the world’s production of neon gas is produced in Ukraine. In addition logistical problems in the global supply chain and rising raw material prices are putting pressure on semiconductor profitability.
This morning ASML, the world’s leader in ultraviolet lithography machines for the semiconductor industry, reported what looks like bad figures but the majority of the miss is due to timing issues related to revenue recognition which is a function of delivery issues due to logistics bottlenecks. Overall, ASML says demand remains very strong and far exceeding the current production capacity.
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