'We could be at saturation levels': analyst on Netflix earnings miss

October 21, 2020
Bernie McTernan
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Yahoo Finance

Bernie McTernan, Rosenblatt Securities Analyst joins Yahoo Finance to discuss the weaker than expected earnings posted by Netflix.

Video Transcript

ADAM SHAPIRO: Well, we want to get to the top story right now, and that's a swing and a miss. Netflix, their earnings after the bell yesterday saw disappointment as they missed, especially on paid streaming subscriber additions. Only 2.2 million, this is the slowest pace in quite a while for the streaming service. We're watching their shares trade down now about 6.5%.

To help us break down these numbers even further and get a picture of where they go from here, we invite into the stream Bernie McTernan. He's Rosenblatt Securities Analyst joining us from Fairfield, Connecticut. And what stood out to you most? Was it the surprise in subscriber growth, or was there another issue we should be concerned about?

BERNIE MCTERNAN: Yeah, no, so for Netflix, the most important thing is subscriber growth. Expectations were high, and they missed, and so that's why the stock's trading off. And as we look forward, we think expectations are actually too high for 2021. We're about 5% to 10% below the Street on '21 adds. The bright spot for Netflix was free cash flow, but it's going to be a tough for them to navigate from going from a growth company to potentially, you know, one focused on free cash flow and value.

JULIE HYMAN: Hey, Bernie. It's Julie. So if you could sort of just explain that a little bit more, the slowing subscriber growth. Is it a matter of competition from the other streaming services? Is it a matter of it sort of reaching critical masks and penetration? Or what's going to drive that slowdown?

BERNIE MCTERNAN: So I think that's what you're seeing in the US and Europe where penetration is the highest. In the US and Canada, subscribers are essentially flat sequentially. We were actually looking for a loss, so that was better than expected. But for Europe, we're actually forecasting adds to be down year over year, which is pretty incredible considering what the tailwind they have right now with the pandemic in the first half of the year. So the first half was a banner six months, and then the second half, you're really dealing with that whole forward, and we think you really dealing with it through next year too.

And so don't forget the content slate is going to be weighted towards the second half of the year. So if you're bullish on the stock, you're thinking A, subscriber, the guides conservative, especially given Spencer Wang's comments last night that if the quarter went 48 hours longer, they would have actually slightly beat expectations. And then also you're focused on the price increase, the thing that Netflix has unlimited pricing power.

Just where we come out is that on the former, that subscriber estimates are conservative, we just think that we're further along in the growth curve, and that penetration is already high and that we could be at saturation levels for S5 in the US. And then if we think about price increases, macroeconomic headwinds, content headwinds, as I mentioned before, even things like "Parks and Rec" and "The Office" leaving the service, and then competition. You know, things like Disney Plus, HBO Max, Apple TV Plus, you know, all of these are just making it more of a difficult scenario for Netflix at the moment.

JULIA LA ROCHE: Bernie, it's Julia La Roche, and it's interesting to hear you talk about, you know, that we're pretty far ahead when it comes to the growth here, and you're just mentioning some of the headwinds that they're facing going forward. In their letter, they said, you know, the state of the pandemic and its impact continues to make projections very uncertain. But as the world hopefully recovers in 2021, we expect that our growth will revert back to levels similar to pre-COVID. You would think that COVID would kind of be the time where the streaming would see a real boom. Just I mean, anecdotally, I feel like I've signed up for more streaming services than I ever have, probably watched more TV and content than I ever have. So is there a path forward for them to get back to growth?

BERNIE MCTERNAN: I think on the subscriber side, it's going to be difficult, which is why price increases is becoming more and more part of the story here. We think that subscriber growth is going to go from the 20% range to probably low to, you know, low teens, and it's just a difficult scenario for the company. And again, we're not saying that Netflix isn't a great company. Streaming is the future of media, the future of TV, but you have to think about where they are.

So if we think about media companies we want to recommend to our clients owning, it's Disney. And Disney on December 10, we're going to learn a whole lot more about them closing that gap even more with Netflix. Disney has about 100 million global streaming subscribers right now. We think they could get to 200 million potentially in 18 to 24 months. And then if we're thinking about COVID beneficiaries, we're thinking Peloton. Peloton only has a million connected fitness subscribers right now, and they're using the same disruption playbook that Netflix used to disrupt the media industry to disrupt the global fitness market.

DAN ROBERTS: Bernie, Dan Roberts here. Can we talk more about specifically that point of the pull forward in demand? And it's so funny you just mentioned Peloton, because that was another company where earlier in the pandemic, some analysts were concerned that the great sales Peloton was seeing were just a pull forward in demand. For now with Peloton, it looks like that wasn't the case. They're still seeing a lot of orders, but it was interesting to me to see the Netflix earnings release actually specifically blame a pull forward effect.

I mean, how plausible is that to you? The idea that you know a number of people were signing up for Netflix earlier in the pandemic and I guess that maybe would have waited or would have signed up later? I mean, talk to us a little bit more about that. Is that really in effect that we're seeing, and is that going to punish or ding Netflix? The idea that now, it's almost like too many people signed up. You know, I saw them cite a figure that in the first half of 2020, we got more new adds than we got in all of 2019. And a little bit, that looks like an excuse, but it's true. They did very, very well in the first half of 2020. It seems a little bit like now just being punished by that success.

BERNIE MCTERNAN: Yeah. Well, so what's the stock market, and it's, you know, what are you going to do going forward? And we actually titled our note last night "The Other Side." And that's we're going to be dealing with. You went through this amazing six month period where net adds in the first half of '19-- or sorry, first half a '20 were greater than all of 2019, and then now it's what are you going to do for me in the future?

And so if you think about it, you know, you just even anecdotally, you know, if you talk to people, like if you don't have Netflix now, when are you ever going to get? And one of the interesting things to us is that we just looked at where consensus estimates have gone. So overall, if you add up 2020 and 2021 consensus estimates for paid net adds, they're up about 20% in aggregate.

That's a 33% increase in '20 and 6% increase in '21. And because of that pull forward, and that's why I'm saying that we're about 5% to 10% below consensus, it doesn't make sense to us that estimates actually should be rising for '21. We think they should be going down, especially where you are on the growth curve in that you're pulling forward a potential air pocket in the US and Europe.

JULIE HYMAN: Bernie, thanks so much. Good to see you. Bernie McTernan of Rosenblatt Securities. Appreciate it.

BERNIE MCTERNAN: Thanks for having me.

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