Netflix – The inflation effect

Netflix pays the price for its high multiple.

• Netflix reported its first subscriber decline as the cost of living crisis is forcing users to tighten their belts which triggered a 25% decline in the shares once again highlighting the risks of high multiple stocks.
• Q1 2022 revenue / EPS were $7.87bn / $3.53 broadly in line with consensus at $7.94bn / $2.91 but it was subscriber numbers where the real problem was to be found.
• Global streaming subscriber numbers declined by 0.2m compared to guidance given in January of 2.50m additions.
• Netflix’s suspension of Russia results in a loss of 0.7m users but even adjusting for this, Netflix was still short by 1.8m new users.
• The net result was another hammering for Netflix’s share price bringing the company down another 25% in after hours-trading putting the shares down 62% from their October highs.
• Most commentators are following the company and putting this down to competition, but I am not so sure.
• The main reason for this is that something has clearly changed in the last 3 months but the visibility of new streaming competitors was as clear in January as it is today.
• Hence, competition would have been taken into account when the company gave its guidance in January.
• Consequently, I think that there is something else going on here and that something is inflation.
• The latest CPI figure for March measures US inflation at 8.5% YoY but this is only half of the story.
• This is because the way inflation is calculated has been changed in recent years.
• Inflation is being compared to the early ’80s where inflation peaked at 13.5% in 1980 but the comparison is not being fairly made due to the change in methodology.
• The biggest change is how housing costs are accounted for in the CPI and if one uses the same method that was used in 1980, then the March 2022 CPI is already above its 1980 peak and is somewhere around 15%.
• I suspect that it is this that is causing the cancellations as consumers allocate less of their budget to entertainment and reduce the number of streaming subscriptions that they have.
• Kantar, the analysis firm, has already reported signs of this (see here) as its survey showed that UK households are already cutting streaming subscriptions as a result of the cost of living increase.
• Furthermore, there is no sign of inflation softening as 1 in 3 US dollars and 1 in 4 British pounds in circulation were printed in the last 2 years and prices need to rise to adjust for this sudden spike in the money supply.
• At this rate, it will be 2 or 3 years before inflation begins to come back down meaning that the outlook for companies that rely on discretionary consumer spending are going to have a tough time.
• However, believe it or not, Netflix is beginning to knock on the door of value territory.
• The company should be able to earn around $12 in EPS this year which at the after-hours price of $259.82 puts the company on a 2022 PER of 21.6x.
• This is still not cheap, but it demonstrates that the multiple of Netflix is unravelling very quickly meaning that when all of the momentum and narrative-driven money has finally given up and sold out, then there may be good value to be had.
• We are not even close to this territory yet, but this is now one to keep an eye on as it is going to fall further as inflation continues to erode its outlook and sentiment sours further.