Netflix Misses Q1 Subscriber Targets, Blaming Covid-19 Issues, But Beats Financial Forecasts

Dade Hayes and Jill Goldsmith
·5 min read

Netflix reported 208 million global subscribers as of the end of the first quarter, missing its own prediction for 210 million.

The streaming giant did beat financial targets, though with earnings per share of $3.75 coming in well ahead of Wall Street analysts’ expectations. Revenue of $7.16 billion also topped the Street.

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The subscriber shortfall, which caused the stock to drop more than 10% in after-hours trading, was blamed on issues related to the coronavirus. Simply put, the pandemic gaveth, but also taketh away. “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,” the company said in its quarterly letter to shareholders. “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.”

A degree of “uncertainty” about Covid would linger in the short-term, but the long-term trend of streaming replacing linear TV remains in effect, the letter affirmed.

Net cash from operations surged to $777 million in the quarter from $260 million and free cash flow of $692 million was up from $162 million. Netflix confirmed a key metric — that it’s on track to free cash flow break even this year and doesn’t need outside financing anymore to fund day-to-day business. That was a milestone affirmed in the company’s January report, and only reaffirmed the bull thesis as the entire entertainment business continues its shift to streaming.

Another advantage the company sees in its service is low churn, with the rate in the quarter dropping below the year-ago level. Already, Netflix’s mid-single-digit churn is the envy of the industry. Also, having a stable base of subscribers gives the company pricing power. “As we improve the service, we can charge a bit more,” the letter straightforwardly noted.

The gain of roughly four million subscribers paled next to the explosion of 15.8 million in the year-ago quarter, when Covid was in its earliest stage. In the current, second quarter ending June 30, the company expects to add just 1 million more paying customers. The tepid outlook — adding 1 million new subscribers would be the lowest year-over-year growth rate in company history — contributed to the stock price decline.

In the letter, the company said the results for the period ending March 31 reflected previous advisories that the record-setting gains would not be able to be sustained. The competitive climate has not affected results, executives insisted. Disney, Apple, NBCUniversal, WarnerMedia, Discovery all launching new services over the past 18 months, and ViacomCBS has also expanded and rebranded CBS All Access.

“We don’t believe competitive intensity materially changed in the quarter or was a material factor in the variance as the over-forecast was across all of our regions,” the company said. “We also saw similar percentage year-over-year declines in paid net adds in all regions …. whereas the level of competitive intensity varies by country.”

During an analyst-moderated video interview with the management team about the results, execs reaffirmed that data indicated rival services weren’t an issue. “Competition is high and has always been high,” Co-CEO Reed Hastings said. He cited Amazon Prime Video and Hulu, with which Netflix has competed for 13 and 14 years, respectively.

When moderator Nidhi Gupta of Fidelity Management & Research suggested Disney is “possibly the biggest direct competitor you might ever see,” Hastings disagreed. Compared with linear TV and YouTube, he said, Disney is “considerably smaller, so we’re sort of in the middle of the pack.”

Probed about the subscriber miss, CFO Spence Neumann Covid created “short-term choppiness.” He noted that the company’s five biggest blown forecasts have come during the past five quarters, due to the pandemic.

Even before today’s 5% dip in the regular trading day and the after-hours plunge, investors have taken a breather from their long-term Netflix enthusiasm. The company’s shares are roughly at the break-even point in 2021 to date after a bull run through most of 2020. Skepticism about the company’s competitive moat has hampered the stock recently, Management at Netflix has stayed sanguine, noting they long expected challengers and that the total global market for streaming is in its infancy, with Netflix capturing maybe 10% of it.

Comparisons between the current year and 2020, however, will be difficult given the significant tailwind of the pandemic. Tiger King, a breakout reality series and maybe the ultimate talisman of quarantine streaming, premiered March 20 of last year. Lockdowns in Europe and Asia were already well under way at that point. Netflix does not operate in China.

In all of last year, Netflix added 37 million subscribers, most of that in the first half of the year.

Investors hammered the stock the last time it had as big of a subscriber miss, which was in 2019. But shares have gone on to rise more than 70% since then, even as rival streaming services have debuted.

Volatility is nothing new for the shares, however. Despite vulnerability to swings in valuation due to subscriber trends, the company’s overall improved financial position yielded an upgrade by Moody’s Investor Services last week.

“The performance of Netflix in the second half of 2020 materially exceeded our,” said SVP Neil Begley, with favorable developments “pulling forward the credit improvement trend by as much as another year.” He gave it two-notch upgrade, maintaining a positive outlook.

Moody’s cited sustained stronger subscriber growth in the second half of 2020; improved pricing power and in the company’s more mature markets as exhibited by the absence of any material increase in “materially higher cash balances and improving cash flows.”

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