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Netflix Reports Sharp Slowdown in User Growth: Bad News?

Shares fall as video service reports lowest number of new additions in two years

Netflix has reported its weakest subscriber expansion in three years, as the streaming-video company suffered a sharp slowdown in net customer additions in the U.S. and abroad. Image: Bloomberg

By

Shalini Ramachandran and

Maria Armental

Updated July 18, 2016 10:33 p.m. ET

Netflix Inc. on Monday reported its weakest subscriber expansion in three years, as the streaming-video company suffered a sharp slowdown in net customer additions in the U.S. and abroad.

Shares of Netflix, down 14% this year, fell 13% in after-hours trading.

During the second quarter, Netflix added 160,000 subscribers in the U.S. and 1.52 million in international markets, below expectations of 500,000 in the U.S. and 2 million abroad. It ended the quarter with 83.18 million subscribers.

The Los Gatos, Calif.-based company said price increases for existing subscribers led to higher service cancellations and contributed to its weaker-than-expected results. In the U.S., more than half its customers had been “grandfathered” under lower prices but will be phased into higher rates this year.

“Whatever the price is for something, people don’t like it to go up,” Chief Executive Reed Hastings said on a videoconference call with analysts. “We apologize for the volatility; I know it’s not easy on everyone,” he said. “The big picture is very much intact.”

Drexel Hamilton analyst Tony Wible said investors are missing the bigger picture, because the higher revenue from the price increase more than outweighs the negative of losing some subscribers. Netflix’s revenue in the quarter jumped 28% to $2.11 billion.

Mr. Wible said that the hit to Netflix’s stock is a buying opportunity “at a time when most media is facing unsustainable financial pressures.”

For the third quarter, Netflix projected a modest increase of 300,000 U.S. customers, due to the phasing in of the price increases and Olympics coverage that could potentially discourage new subscriber sign-ups.

Despite the disappointing subscriber results, Netflix reported earnings growth that handily beat analysts’ earnings estimates and its prior guidance, thanks in part to lower content costs.

Market Talk

Netflix Price Hikes Hit Existing Customers. Netflix CEO Reed Hastings said he’s “confident” that the softness in subscriber growth in the June quarter wasn’t due to increased competition from the likes of Amazon’s Prime video service. On a video conference call with analysts, he continued to attribute the subscriber miss to price hikes being rolled out to existing customers who had previously been “grandfathered” under the prior, cheaper pricing tiers. “This is really around change resistance,” Mr. Hastings said. “Whatever the price is for something, people don’t like it to go up.” Netflix executives continued to note that the price hike didn’t dissuade new customers from signing up—gross additions—but rather, turned off existing subscribers confronted with an increase. Mr. Hastings said with the increased revenue, “we continue to invest in better and better content” and “that’s what makes us feel very strong and positive about the long-term and that it’s a short-term phenomenon.” ([email protected]; @ShaliniWSJ)

Olympics Could Hurt Netflix Subscriber Growth. Netflix Chief Financial Officer David Wells, speaking on the company’s 2Q earnings video call, warned that Olympics coverage world-wide in 3Q may discourage new subscriber signups in a “small” but “meaningful” way. Netflix forecast 300,000 US subscriber additions for the third quarter, compared to the 880,000 it added a year ago, due in part to the Olympics and to continued softness as it rolls out price hikes to existing customers. ([email protected]; @shaliniwsj)

In a letter to shareholders, Netflix said it wasn’t revising its stated U.S. subscriber goals to sign up 60 million to 90 million customers in the long term.

Netflix’s addition of 1.68 million streaming subscribers in the latest quarter was the weakest tally since Netflix added 1.24 million users in the June 2013 quarter.

The streaming giant, which is facing increasing competition from Amazon.com Inc. and Hulu along with a range of other web TV services, has said it hopes to complete its global expansion this year. The company said in the letter to shareholders it is still exploring an entry into China, but that “the regulatory climate in China for our service has become more challenging.”

Netflix continues to open its wallet for programming. It streaming content obligations ballooned to $13.2 billion at the quarter’s end, from $10.1 billion a year ago.

Also on Monday, Netflix announced a deal to premiere CBS Corp. ’s new “Star Trek” original series in 188 countries, excluding the U.S. and Canada. The series, which is being created for CBS’ streaming service CBS All Access, marks the first time Netflix has acquired the international rights for an original show made by a rival streaming service.

Netflix has started allowing original shows, such as “Club de Cuervos,” “Narcos” and “Marseille,” to air on broadcast TV before the next season’s premiere on Netflix. “The danger,“ Netflix acknowledged in the letter, “is diluting the perception that Netflix original content is only on Netflix, so we are testing cautiously.”

Mr. Hastings said Netflix is studying adding the ability to let users download shows to watch them later, a feature that could help in markets where cellular networks aren’t as strong as in the U.S.

Netflix reported second-quarter profit of $40.8 million, or 9 cents a share, compared with $26.3 million, or 6 cents a share, a year earlier. Excluding certain items, profit fell to 7 cents a share from 10 cents a share a year earlier.

Analysts surveyed by Thomson Reuters had projected a profit of 2 cents a share on $2.11 billion in revenue.

In a bright spot, Netflix said the markets that it launched before 2014—which include Latin America, Canada, the Nordics, U.K. and Ireland—are on track to deliver a contribution profit of around $500 million this year and are each individually profitable. Netflix hasn’t previously disclosed the health of those individual markets.

The company said it expects to run at “break even” this year and “generate material profits in 2017 and beyond” by reducing international losses and continuing to grow in the U.S.

Click the following link to see a video on Netflix and the slowdown in the growth of users: http://www.wsj.com/video/netflix-misses-subscriptions-target/146BEEE5-724A-4FC2-96F5-41ADB5C83476.html