Netflix earnings miss ‘is a body blow to the bull case’: Analyst

Manhattan Venture Partners Head of Research Santosh Rao joins Yahoo Finance Live to talk about Netflix's reported subscriber loss and revenue slowdown for Q1, the outlook for the streaming platform, market expansion, and subscription prices.

Video Transcript

- Welcome back to Yahoo Finance Live, everyone. We're tracking shares of NFLX, Netflix. Those shares, as Alicia Keys would say, fallen, in after hours trading by more than 20%. Following its Q1 earnings report, the company lost subscribers for the first time in 10 years.

For more analysis, let's bring in Santosh Rao, who is the Manhattan Venture Partners head of research. Just your reaction on this headline number. And of course, the first time losing subscribers in 10 years for the streaming giant.

SANTOSH RAO: Hi. Thanks for having me. Well, this is a body blow to the bull case, definitely, the Netflix story, the subscriber story. Netflix was all about subscribers for so long and now you saw that. And it's really taking it on the chin here.

And it was bad across the board. So let's wait and see. Let's see what the conference call says why did this happen. But it looks like a systemic thing across the board, the subscriber count was down. So let's see. Is it churn, is it competition, is it just I mean, the pricing part of it? Or what exactly is going on and what are they saying and how are they preparing for the future.

But net-net, a bad number and everything has to be re-rated. The whole story has to be re-evaluated from a lower base now. I mean, the multiples are getting compelling at this point but we need to see that the growth story is still intact and they have a strategy to tackle the challenges ahead.

- Santosh, they lost a million subs with discontinuing service in Russia after the invasion of Ukraine. All that aside, a net loss of 200,000 is devastating for them. What changes might they make in the face of this?

SANTOSH RAO: Well, I think they have to continue what they're doing. And they had a whole slate of new releases and they have some hopefully there will be more stickiness down the road in the later half of the year. So that will catch up. Content is important and that's the key for their key differentiation at this point.

Competition is there. They are spending quite a bit. They will be spending $8 billion. So they may have to optimize that. So net-net I think they need to figure out where they're going wrong. But at this point, they should continue. But then more than that, they need to get into some other sticky things like more gaming, maybe sports, advertising, revenue, of course.

Go on all these additional levers that they need to pull because this is not working. The traditional core business may have peaked, especially in their core markets. Emerging markets are still good. But we need to see. I mean, APAC and EMEA regions are still under penetrated so they need to go there with a more localized and better strategy, with better pricing as well.

I don't know if the pricing is sticking. We'll see whether that's helping them or not. Because they are the highest on the street overall, in terms of the pricing, monthly subscription. So we'll see.

They need to look at a lot of things. Back to the drawing board. Really evaluate where they are really going down, getting hit badly.

- You raise an interesting point about emerging markets. Netflix clearly had a lot of international content that it continues to put on its platform. Where should it be looking then in terms of expansion for more subscribers?

SANTOSH RAO: Well, India is a great market. Japan is a great market. They need to keep on growing there. Those are the key areas. And even here, see overall there are about $700 million broadband homes around the world. So it's totally under penetrated. Those regions are under penetrated.

Ther's still margin to grow. Subscription is the business. Streaming, rather, is the future. But they need to-- the incremental subscriber is not going to be easy to acquire so they need good content, continue with what they're doing. And content, they have to spend. That's the key to pull people in. But they need more sticky factors.

So I think I would say emerging Japan, India, and all those areas, which are under penetrated so far. They are the prime markets to attack. And even though the RPU is low there, but they need to get the volume there as well.

And then stay in the core market is also going to compete. Right now the new competition is coming up so you can feel the pressure there. But if they stay on the game, I think they can kind of establish their niche in there in the core markets as well. But overall, they need to grow and they need to compete. And that's the new reality for them.

- Santosh, I want to come back to something that you were mentioning a moment ago in whether this is something across industry that we should look out for over the course of this earnings season or if this is specific to Netflix. But I'm tracking shares of companies like Disney. DIS shares are down in after hours trading by about 3.4%.

I'm looking at my screen as well at WBD, which is, of course, the newly formed Discovery Inc., if you will, that is going to also continue to play in this space. And so with that in mind, how much of this do you think we will see show up in some of these other streaming giant earnings reports?

SANTOSH RAO: It will be across the board. I mean, it's not just Netflix in particular. I think it's going to be-- you're going to see the numbers across the board come down. Because that's the new reality. And don't forget, you have the macro factors as well, inflation and all that. This is a discretionary spend. As much as it's required and popular, it's an extra $30, 40 bucks or whatever, $16, 20 bucks out there. And if you spend two or three on two or three apps, it's a lot of money and people are cutting back.

So that I'm sure, is also playing into this whole demand side of the equation. So let's see what it is. But I expect across the board, reductions in the subscriber count.

- And perhaps they explain that in their letter to investors that says COVID clouded the picture by significantly increasing our growth in 2020, leading us to believe that most of our slowing growth in 2001 was due to the COVID pull forward. So you may see a similar statement from other streamers. Moving forward do we expect a model that includes ad supported, free or even lower priced content?

SANTOSH RAO: Absolutely. I think ad, it looks like they need to go there. Even though they don't want to go there, I think looks like they may have to, if that's the only source, only good source to go to at this point. Even though they don't prefer that. I mean, Netflix is known for its ad free content, which is good, but at some point you have to get real and say, you know what, we need revenues.

And that's the big push on that. The bear case, if there is one, was can they maintain margins? Can they get the cash flow numbers, the free cash flow numbers that they were targeting? Can they hit the subscriber count overall? That metric seems to be in real pain right now, the subscriber count.

But if they can maintain their profitability, show the revenue growth, I think they can still be in the game. They are still the incumbent leader so they can still manage that. But they still need to execute.

- Very quickly, what we do have here, because in not just a decelerating subscriber environment, but now a declining subscriber environment as we've seen in these figures, what does that tell to you-- what does that tell you about the price point that we're going to have to look at across the board and the adjustments that are going to be necessary there? We only have about 30 seconds.

SANTOSH RAO: Yeah, I think price points are important. If this decline was due to the price increases, I think you're going to see some pullback there as well. Because at some point, you have to get very optimized. You have to optimize the pricing point. So you will see-- I think there is a cap to how much higher how high they can go and they may have to come down more, if needed, to maintain their subscriber.

- Santosh Rao, who is the Manhattan Venture Partners head of research, breaking down Netflix earnings with us here this afternoon. We appreciate it very much.