Netflix – The addition game

Netflix needs subscribers.

• Netflix is being hailed as one of the lockdown winners and while usage of the service has probably jumped 30% or more in the last quarter, Netflix needs to add subscribers to increase revenues and justify its recent rally.
• RFM research has found that most of the digital ecosystem will not benefit from the pandemic induced lockdown as while their usage has surged, most of their business models are not well suited to benefit from the increased usage.
• This includes Apple and the handset makers who monetise via device shipments (likely to fall 10-20% in 2020) and Google and co. who monetise via advertising where the customers have already made huge cuts to marketing spend.
• This leaves subscription where the revenue model falls into two camps: all you can eat for a monthly fee or pay as you go.
• Netflix, Spotify and so on fall into the first of these two camps which is why a 30% increase in usage does not necessarily benefit Netflix’s top line.
• In order to see growth in revenues, Netflix needs to restart the stalled growth in subscribers which is what the market is currently pricing in.
• There is some indication that downloads of the Netflix app have jumped in the last quarter but whether that is for new subscriptions or existing users putting it on new devices is unclear.
• Furthermore, this trend is not appearing in App Annie’s charts where Zoom remains the clear No. 1 app by downloads.
• In fact, without a resumption of subscriber growth, Netflix is likely to experience margin compression due to its increasing spend at AWS.
• The cloud business is a pay for what you use business meaning that if usage of Netflix goes up by 30%, then its AWS bill also goes up by 30%.
• This is why the rally in Amazon is far more justifiable than the rally Netflix.
• Amazon along with Microsoft are perfectly positioned and Amazon’s business model is correctly aligned (with AWS and e-commerce) to directly benefit from increased usage both of AWS and its e-commerce marketplace.
• This is why for the first time ever, I have had a favourable view towards Amazon (see here) with the strong and direct benefit fro the lockdown outweighing my persistent issues with its valuation.
• Amazon has already rallied 19% since that time (April 3^rd) with Microsoft having rallied 12% with probably further to go.
• Netflix has rallied 14% since April 3^rd when I made these observations, and this is the rally that is more difficult to justify.
• The share price is assuming a big jump in subscribers which is not given in contrast to the jump in usage which is clear for all to see.
• Hence, I think that the risk-reward profile on Netflix is much less favourable than it is on Amazon, Microsoft or Alibaba.
• If I had to be in the market, which I don’t and so I am not, this is where I would be.