Netflix Q2 2020 – Peter and Paul.

Netflix robbed Peter to pay Paul.

• Netflix reported good results, but it turns out that the very strong subscriber numbers in H1 2020 were mostly due to pulling forward user acquisitions that would have occurred in the future meaning a softer H2 2020.
• Q2 2020 revenues / EPS were $6.15bn / $1.59 ahead of revenue expectations of $6.08bn but behind EPS expectations of $1.83
• However, the results were all about the subscriber numbers which came in at 10m new additions comfortably ahead of forecasts of 7.5m.
• However, subscriber additions in Q3 2020 are expected to be way below forecasts at just 2.5m compared to expectations of 5m or more.
• This is what spooked the market triggering a 10% correction in the share price.
• With the shares on 2020 PER of 81.9x, the kind of growth that the pandemic triggered needs to continue into 2021 and beyond and it now appears that this will not be the case.
• In effect, Netflix has borrowed from the future to pay for the present and now the bill has come due,  meaning lower growth going forward.
• This by no means a slight on the company or its management, as they have as little visibility on the pandemic as the rest of us, but it does sound a severe warning for the unrealistic valuation of the shares.
• It also reinforces concerns picked up by RFM research (see here and here) that the business model that relies on subscriber growth is not nearly as robust through the pandemic as one that relies on usage.
• This means that companies like Netflix and Spotify only do really well when they add lots of new subscribers and they see no real benefit when their existing customers use their service more.
• By contrast the cloud providers like Amazon, Microsoft and Alibaba benefit both from new subscribers and when their exiting customers use their products more.
• This is because their proposition is essentially to turn the fixed cost of a data centre into a variable one meaning that you pay for what you use and no more.
• In the environment where everyone is working at home, going to school at home and socialising via video, traffic has increased substantially and it is the cloud players that have benefitted the most.
• There are no signs of traffic levels abating before there is a vaccine which means the outlook for the rest of 2020 remains strong.
• Hence, I do not see these results as a sign that the cloud players or the productivity device makers will report a similar slowdown.
• Instead, I suspect that the prolonged nature of the pandemic will mean elevated internet traffic and a continuation of the home productivity upgrade trend (upgrading PCs, webcams etc) for some time to come.
• Consequently, I think that Microsoft, Amazon, Intel and so on will not see this sudden reset to a lower level of growth, but instead will guide strongly as the uncertainty keeps much of the economy working and learning from home.
• Microsoft and Intel remain my two favourite ways to play these trends although I remain fairly reticent to own anything in the stock market at the moment.