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2 Jarring Ways Netflix Just Changed Its Tune on Growth

Netflix (NASDAQ: NFLX) shareholders endured painful losses in recent days after the company announced its second straight quarter of sales growth that fell beneath the critical 20% annual rate that it had easily surpassed over the last few years. Worse yet, the streaming video giant sees sales gains slowing to just 10% in the current quarter even after factoring in the price increases that are set to impact U.S. subscribers over the next few weeks.

In a conference call with Wall Street analysts, Co-CEO Reed Hastings and his team projected confidence about the long-term growth opportunity ahead. However, Netflix shifted its outlook in at least two important ways. Let's take a closer look.

Image source: Getty Images.

1. Netflix's pre-pandemic growth rate might not return

COVID-19 scrambled demand trends and added significant noise to Netflix's growth rate. The company's annual gain in subscribers dove to 18 million in 2021 compared to 37 million in 2020. While that shift clearly shows a growth hangover, it now appears that Netflix isn't quickly bouncing back to its pre-pandemic expansion rate.

Management had been expecting that recovery to start in the second half of 2021 with help from Netflix's biggest content release period to date in the fourth quarter. Instead, new subscriber acquisition is weaker than it was in 2019, which is one major factor behind management's forecast of adding just 2.5 million new members in the first quarter compared to 4 million a year ago.

That sour outlook isn't a case of attempting to underpromise and overdeliver, either. "We think [our prediction] will be accurate," Hastings said in the conference call. "It's not sandbagged at all."

2. Netflix executives aren't sure why growth is slowing

Netflix is also sounding less confident about understanding the factors that are hurting growth today. It could be the flood of competitive content on the market, but that shift would normally show up in increased cancellation rates. It might be pandemic fatigue following almost two years of soaring demand for digital entertainment. Yet the average user is still spending more hours engaged with the service.

The company is struggling to attract new users even though its service has never been better, and its release calendar is packed with exclusive hits across several movie and TV niches. Executives highlighted "uncertainty and increasing competition" in their shareholder letter and described challenges around identifying the problem: "We're trying to pinpoint what that is," CFO Spencer Neumann said in response to a question about why the Q1 guidance was so weak.

What hasn't changed for Netflix

This is far from a broken business model. Netflix is still on track to generate positive cash flow this year, with increasing cash production rates from there. Profitability is still expanding by 3 percentage points, roughly, each year, even though 2022's result will be lower thanks to currency exchange rate shifts.

User engagement is rising, and Netflix is finding plenty of ways to thrill its customers, whether it's with global hits like Don't Look Up, returning franchises like The Witcher, or its new video game unit. "We're continually improving [the service]," executives said, "so that we can please our members [and] grow our share of leisure time."

Netflix still accounts for a relatively small percentage of TV viewing, and there's a long runway of growth ahead as that metric rises and as the global streaming market expands.

However, what's changed lately is that growth trends aren't bouncing back to their pre-COVID rates, and it's unclear whether Netflix can make that rebound happen simply by releasing great content and improving the service. That strategy has been a runaway success for most of the past decade. It might be bumping up against diminishing returns now.

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Demitri Kalogeropoulos owns Netflix. The Motley Fool owns and recommends Netflix. The Motley Fool has a disclosure policy.


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