Don't Write Off Netflix Just Yet

In the last twenty-four hours the news cycle has been awash with a "Netflix is dommed' narrative. Well, it's more of a "Hi Netflix, welcome to the new world" line but the point is all the same as many now view Netflix as in a precarious position, and one that's about to become even more unsteady over the next few months.

Netflix's problem, if you are to believe the narrative, is Disney. But that's not Netflix's only problem as there's also WarnerMedia – or as it is now being called HBO Max. Both of these services are due to hit the market within the six to nine months and both are looking at generating big numbers straight out the door.

Those numbers are not expected to simply come out of thin air but are expected to impact on existing subscription services. As Netflix is one of the main subscriptions for most people, it is believed by some that Netflix will be hit the hardest.

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This Netflix doomed scenario has been circulating for some time now, although the rhetoric picked up in the last twenty-four hours due to the company's latest earnings results. The short of which was Netflix only picked up 2.7 million new subs in the second quarter of this year.

The reason "only" matters is the company had been expected to pick up around five million during the quarter. Evidently, Netflix did not perform as well as expected but that's not the same as linking what happened in the second quarter with what's going to happen (or not happen) in the future.

First off, a gain is a gain and 2.7 million is nothing to be ashamed of, even for Netflix. What's more, the company itself must have been expecting a year-over-year decline to begin with as it had only forecast five million when in Q2 2018 the company attracted 5.5 million new subs. Yes, there's a big difference between an expected decline of half a million and two-and-a-half million but that still does not change the fact that a decline was expected.

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What's more, things have to be taken in context. For example, in Q1 2019 Netflix added almost ten million (9.6M) subs. In other words, in the three-months before the current 'doomed' quarter, Netflix has its best quarter ever, in terms of new adds.

What changed between Q1 and Q2 to see things go from good to bad? Nothing externally anyway. Nothing materially changed outside of Netflix in that period and that's a very important point to note. Disney and WarnerMedia's services were already on the cards and neither service has launched yet, and so realistically neither of them could have impacted on Netflix's Q2. They are unrelated in spite of what media reports might otherwise suggest at the moment.

The only change that did happen was internally as the second quarter of 2019 was the first full quarter where the new price increase was in effect. This increase affected both new and existing subscribers and is likely to have contributed somewhat to the lowered subs for the quarter. Although this is something Netflix would have saw coming as price increases tend to have a negative effect on growth in the short-term. For some, the short-term starts to become more long-term as the market is currently seeing with DIRECTV NOW.

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Furthermore, it was then, at the point of announcing its best subscriber quarter ever that the company announced its five million forecast for Q2. The company was actively saying we expect to see half the number of subs in the next three-months compared to what we have just seen in the last three months – further evidence that nothing actually happened in Q2 outside of Netflix's own actions. The forecast may have downplayed the quarter-over-quarter change, but it was still very much in line with the company's own prediction.

Another contextual way of looking at Q2 is to look at H1 in general. Considering Netflix's Q2 was okay (a gain is a gain) and its Q1 was great, the H1 figure comes in at 12.3 million new subs in 2019 so far. This compares to 13.7 million for the same period in 2018. So yes, year-over-year the half is down but not by that much and that's keeping in mind the Netflix doomsday scenario has not developed into what it is now in the year before.

What's even more revealing is that last year the same trend was also in effect. In Q1 2018 Netflix announced 8.26 million new subs and this was followed with 5.4 million for Q2. The drop may not have been as significant as that in 2019, but it was significant enough, and the 2019 drop appears all the worse due to Netflix having just experienced its best quarter ever. It was not until Q4 2018 when the company registered new subs higher than it did in Q1 of the same year.

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In fact, that 8.26 million subs for Q1 2018 was actually lower than the quarter before (8.33 million) showing the Q2 drop in 2018 followed back to back high quarters. That's exactly what we are seeing here as the drop in 2019's Q2 follows on from the record 9.6 million new subs in Q1 2019 and the 8.8 million recorded for Q4 2018.

Where the picture gets a little murkier is if focusing on the U.S. alone. One of the big Netflix news headlines from this week is that in spite of the overall 2.7 million gain in the second quarter, the subscription service actually lost subscribers in the U.S. – 126,000 to be exact bringing its total U.S. subscriber base down to 60.1 million compared to the 60.23 million at the end of Q1 2019.

This again may have been the result of the recent price increase with some existing subscribers unwilling to pay the $2 more Netflix wanted. However, even when there's a clear loss, things are still not so straightforward.

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For example, in Q2 2019 Netflix confirmed 1.58 million free trials were taken advantage of by subscribers in the U.S. alone. This is higher than it was in Q1 2019 when Netflix saw its record uptick in new paid subscribers. For reference, of that 9.6 million new subs for Q1 2019, 1.74 million were new U.S. subscribers.

One suggestion could be that in addition to those who were opting to leave due to among other things, the latest price hike, those checking out the free trial may not have converted in as high of a number as they did in the previous quarter. Whether that's because they felt the price was too high after experiencing the service, or the content was not quite as varied or in line with their tastes as they expected, or they just wanted to check out Netflix's new "Murder Mystery" when it launched in Q2, remains to be seen. Irrespective of the reason, the number of free trials suggest more people checked out the service for the first time in Q2 than they did in Q1.

The fact they didn't convert, or convert in high enough numbers to counteract the lost subscribers is irrelevant to the fact that interest in the service was higher than it was in the quarter before.

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The overall point, it is almost impossible with Netflix to garner any industry changes based on one quarter alone. Netflix has good quarters and some not so good quarters and sometimes the latter follows the former as appears to have been the case in 2019 so far.

The landscape is indeed going to change over the next twelve months with many major players emerging and all looking for their perceived fair share of the streaming pie. That may have an impact on Netflix but that will come down to Netflix's own actions more so than anyone else's. Netflix has already proven it can generate hit shows and movies and this is going to be key to its success in the new subscription era.

For the first time Netflix will have to stand on its own two feet and not rely on shows pulled from other companies and instead output content that's as high in quantity as it has already shown it can do in quality. If Netflix does manage this then companies like Disney and WarnerMedia may find they are battling with each other more than they are battling with Netflix to become the go-to second-place major subscription for most people.

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That is, at least for the sixty million people in the U.S., and the 150 million worldwide who are already Netflix subscribers, and have been for years.

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