Tech

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

Netflix has suddenly run into a bout of buffering.

The hiccups in its streaming strategy call into question the company's plans for delivering solid profits in the U.S. to finance a sweeping overseas expansion. Both elements of that strategy are now in doubt, at least temporarily. 

Netflix on Monday reported better-than-expected numbers of new customers both outside the U.S. and at home, where the company had been having trouble signing up as many streaming subscribers as it did in prior years. As stock investors tend to do, however, they skipped over past results to fixate on the future, where there are troubling signs everywhere. Investors understandably panicked, pushing Netflix shares down by 10 percent in after-hours trading. 

Stutter Step
Netflix's stock had been rising but fell 10 percent after hours on Monday
Source: Bloomberg

Netflix expects to add just half a million net new Web video customers in the U.S. during the quarter ending in June. That would be 45 percent lower than the 900,000 U.S. customers Netflix signed up in the second quarter of 2015. 

If the company meets its forecast, it will be the seventh quarter in the last nine in which Netflix signed up fewer new streaming subscribers in the U.S. than it did in the period a year earlier. The company's explanation for its forecast included the inelegant phrase "un-grandfathering" -- a reference not to euthanasia of the elderly, but to price increases that are beginning to add $1 or $2 a month to the bills of many existing streaming subscribers.

Domestic Disturbance
It's getting harder for Netflix to sign up U.S. streaming subscribers now that it's so big and Americans have more options for digital video services
Source: Bloomberg

Netflix had been considered relatively immune to price increases because a high percentage of its customers say they are very satisfied with the service. Just 9 percent of Netflix's customer base had canceled the service in the prior year -- a ditch level lower than other major video services including Amazon, according to research from Parks Associates.

The forecast shows that even Netflix acknowledges the price of its service does matter. The company says it doesn't expect much of an impact long term from its gradually increasing bills; realistically, each time prices go up, customers have a reason to look at improving rival services including Amazon's. 

Perhaps more worrying, the company said its contribution margin -- a measure of profit margin that counts the revenue Netflix takes in minus its costs for serving up video and marketing the service -- would take a temporary breather in the second quarter. Until now, Netflix has paired slowing subscriber growth in the U.S. with climbing profits from each of those subscribers. Any projected change in that formula is an unhealthy sign. 

Profit Breather
Netflix is projecting a dip in contribution margin, an important measure of profits, from its U.S. video-streaming business
Source: Bloomberg
These figures are for contribution margins, or revenue minus costs to provide Web streaming and to market the service.

And even more more worrying is that Netflix hit a wall in its international growth, which is a fixation for Netflix and its investors. The company's forecast calls for international subscriber growth to shift from overdrive to reverse over three months.

Netflix expects about two million net new subscribers outside the U.S., or roughly 16 percent fewer new customers than in the second quarter of 2015 -- breaking a string of impressive growth that has masked Netflix's problems in the U.S. 

Bye-Bye Global Growth
Early on in Netflix's international expansion effort, the company is forecasting a sharp reversal in subscriber growth overseas
Source: Bloomberg

Netflix attributed its meek international subscriber forecast to passing the year mark for its blockbuster launch in Australia and New Zealand. But this is the critical year of Netflix's international expansion effort. If Netflix has already run out of steam in adding customers in new markets, the company can't with a straight face keep selling investors on its tricky and expensive plans for world domination

For most companies, the results Netflix turned in would be good enough. But this is a company whose shares are valued at an astronomical 87 times estimated earnings before interest, taxes, depreciation and amortization for the year, according to Bloomberg data. Free cash flow has turned negative as Netflix spends big on programming and its new country launches.

Netflix needs a steady stream of both big customer counts overseas and growing profits at home. For now, it has neither. 

Netflix Can't Take Over the World

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The count for those who quit Netflix included  people who didn't continue after free trials had expired. 

To contact the author of this story:
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net