Netflix thrived on a need for lockdown escapism but it now has to face up to the reality of a fiercer and more costly battle for eyeballs. The slowdown in subscriber growth was inevitable, not just because more of us are getting off the sofa, it’s also the natural consequence of a more crowded market where participants are spending big to win market share.
By adding 1.5 million net new subscribers during the second quarter, the streaming behemoth may have beaten its own forecast but it was one of its weakest performances in recent history. Guidance of 3.5 million audience growth for the third quarter was also about two million behind Wall Street analysts’ forecasts.
Netflix had already flashed its get out jail free card at investors in the first-quarter results, citing “unprecedented membership growth in 2020” that had pulled forward new subscriptions from 2021. Spencer Neumann, chief financial officer, told investors that it should end the year on a “kind of normalised growth trajectory” after the pandemic “choppiness”.
To quote annoying lockdown speak, it’s likely to be a “new normal”. Analysts this year forecast a revenue growth rate of 19 per cent, easing to 15 per cent in 2022 and 2023. That is behind rates in the mid-20s to 30s reported over the past seven years.
If Netflix is entering a more mature phase of its growth, that is not reflected enough in the market value placed on it. The shares are trading at a toppy seven times forecast sales, which is bang in line with the average multiple over the past five years — a period of fast subscriber growth.
At least the group is turning a profit now. But investor expectations for growth are high here too. The market has placed an enterprise value of almost 32 times earnings before interest, taxes, depreciation and amortisation (ebitda) over the next 12 months.
Doesn’t that look a bit too optimistic? Management has only this year said it could fund its operations through its own cashflow rather than continuing to raise debt externally. But retaining subscribers and fending off competition means there are increasing demands on its cash. Investing in top-quality content costs. To be fair, Netflix has had some corkers over the past 18 months, including the reality series Tiger King and period dramas Bridgerton and The Queen’s Gambit.
Netflix has the largest share of the global video streaming market for digital originals, at 48.3 per cent during the second quarter, according to Parrot Analytics. But that is down from just over 70 per cent in 2018.
Netflix is defending rather than disrupting. Amazon’s Prime Video is its closest competitor in terms of subscribers. But Disney+, which is newer, added 70 million subscribers over the 12 months to April.
Consolidation has given some rivals more muscle. Amazon’s acquisition of the Hollywood studio MGM will give it access to thousands of TV shows and films including the James Bond and Rocky franchises, while the merger of WarnerMedia and Discovery will place the HBO Max and Discovery+ streaming services under one roof with greater financial heft. Netflix is famously not acquisitive, bar the children’s show producer StoryBots and comic book company Millarworld.
Netflix’s more mature North American market is the epicentre of the slowdown in subscriber growth. The vast Indian market is being eyed for expansion but rivals have gained a stronger foothold than it there.
Longer term, there is also the saturation point across these markets — how many users will sign up to three or more streaming services?
Netflix investors may need a reality check.
Advice Avoid
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Frontier Developments
Tencent’s bid for Sumo is set to make investment options in the UK video game industry even more sparse, coming soon after Electronics Arts’ takeout of Codemasters five months earlier. So the logical next question is, who is next? How about Frontier Developments?
Tencent already has a 9 per cent stake in the Cambridge game developer. That’s almost identical to the size of holding it had built before the launch of its offer for Sumo.
Shore Capital upgraded the stock to a “buy”, from “hold” in the wake of the Sumo bid. You wouldn’t blame the Chinese technology group for being interested — retail investors should be too.
A switch away from defensive to recovery stocks hurt sentiment towards the shares. Several delays to game releases have not helped and caused the shares, traded on the Alternative Investment Market, to substantially underperform the benchmark so far this year.
In June it said that “collaboration challenges” associated with home working meant that the release of its F1 management game could slip into early 2023, rather than a slated 2022 deadline. That meant guidance for revenue between £130 million and £150 million next year was weaker than market expectations, although the mid-point of that range would constitute an impressive jump on the £91.6 million being forecast this year.
But the rewards on offer for video game developers are vast. Newzoo, the industry research group, forecasts that revenue generated by the gaming industry will reach almost $205 billion by 2023, growing at a compound annual rate of 7 per cent between 2019 and 2023.
Frontier doesn’t simply own the licences for games including Jurassic World Evolution, it also owns the intellectual property of titles such as Planet Zoo, from which it retains a greater proportion of revenue.
UK-listed shares in the video games sector are highly rated. Frontier has an enterprise value of 24 times forecast ebitda this year, but, for context, that’s below its closest peer, Team17. Frontier’s re-rating potential doesn’t only lie in takeover speculation.
Advice Buy
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