Those hoping that the recent decline in Netflix Inc.’s (NFLX, Financial) share price would put it back in value territory may soon find themselves disappointed.
The company was originally on track to transition from a high-growth stage to a more mature stage, but in pursuit of the earnings multiples of old, it has made a grave mistake that it may never be able to recover from.
I’m talking about the company’s crackdown on password-sharing. Netflix’s management claims the practice of password-sharing is basically equivalent to customers “stealing” revenue that was “rightfully owed” to Netflix. By this logic, the company still has room to grow by collecting the revenue that is being “lost” due to password-sharing. All it has to do is charge extra fees for accounts that register logins from more than one household.
This train of logic reveals an enormous and dangerous disconnect between management’s viewpoint and reality. Here’s why I believe Netflix is making a severe miscalculation here, and why it could plunge the company into a period of long-term subscriber declines (and thus share price declines).
Customers are now the enemy
The primary danger of Netflix’s password-sharing crackdown is that it reveals a fundamental shift in how the company views its customers.
When the company was still in its growth stage, the customers were its lifeblood. Like any great company, it thrived on giving customers what they wanted: on-demand content, full seasons dropping at once, shows targeted towards what viewers liked the most, etc. In fact, they even encouraged password-sharing; the more people that saw and fell in love with their content, the better.
Now, Netflix has changed its tune, characterizing password-sharers as people who have misunderstood the very nature of Netflix's service. In an April 19 letter to shareholders, the company stated:
“Sharing likely helped fuel our growth by getting more people using and enjoying Netflix. And we've always tried to make sharing within a member’s household easy, with features like profiles and multiple streams. While these have been very popular, they’ve created confusion about when and how Netflix can be shared with other households.”
This distinctly antagonistic viewpoint sees customers as confused at best and actively stealing money from the company at worst. Customers tend to flock to products that give them what they want, and being treated as the enemy certainly doesn’t fit that bill.
The myth of “lost revenue”
Netflix’s reasoning for its crackdown on password-sharing is that each account shared across households is resulting in at least one lost subscription. Surely if they were to prevent password-sharing, then they would have two subscriptions or more instead of just one.
Of course, the company doesn’t plan to go as far as completely blocking logins from other locations, at least not at first. The initial plan is to force customers to pay a smaller additional fee for each sub-account, which would likely be around the $3 mark. On some level, the company seems to realize that customers will not be happy with the change, though I believe they are greatly underestimating the backlash.
While the company claims to not yet know what the benefits or drawbacks of this change will be, since it is unprecedented in the streaming industry, we do have a similar example to go off of from the gaming industry.
In the video game industry, it’s inevitable that some customers will be intrigued by certain games but won’t necessarily want to buy them at first. Enter YouTubers who record and upload videos of their playthroughs of games, complete with their own commentary on things like the storyline, characters, game mechanics, etc.
Some video game companies decry this practice because they believe it results in “lost revenue.” However, others enjoy the free publicity that could potentially lead to higher sales. In fact, there’s a significant portion of the gaming community that won’t buy games without seeing at least part of someone else’s playthrough first.
The idea of lost revenue is a myth. Either you have revenue, or you don’t. You can’t lose something that you never had to begin with, and acting on the notion that you can get money from people who have never been willing to pay for your services in the past can easily backfire.
Sure, some Netflix customers will be willing to pay the additional subscription fees for sub-accounts, but some families may believe the content isn’t worth it for the higher price. Some parents only have Netflix so that their kids who are off in college can use it, so they wouldn’t even want the account if their kids couldn’t log in. Those kicked off of shared accounts due to the extra fees might subscribe to Netflix, but they might also go to competitors or forego having their own streaming subscription entirely.
Competitors are getting an unlooked-for opportunity
Last but certainly not least, Netflix’s strategy risks alienating customers at a time when new competitors are cropping up left and right.
These competitors, which include Disney’s (DIS, Financial) Disney+, Amazon’s (AMZN, Financial) Prime Video, Warner Bros. Discovery’s (WBD, Financial) HBO Max and more, still see themselves as being in their growth stages, so they are far more solicitous to customers.
It’s not like it used to be, when Netflix was a unique existence in the market. There are other streaming services now, and while many households maintain more than one streaming subscription, there’s so much content out there these days that no one could possibly hope to watch it all. Thus, the likelihood of angry customers cancelling their Netflix subscriptions and never looking back is a much bigger risk than in the past.
If competitors are smart, they will do everything they can to use this opportunity to take market share from Netflix. The best part is, they don’t necessarily have to do anything different from what they’re already doing; to benefit from Netflix’s crusade against password-sharing, all they have to do is not launch their own crusades against password-sharing.
Takeaway
Netflix may still dominate the on-demand video streaming market in terms of subscriber numbers for now, but on the back of slowing revenue growth and its first subscriber loss in a decade, the share price has plummeted. Investors are realizing the company is nearing market saturation, and that it can’t keep posting high growth numbers forever as its market matures and competitors make themselves known.
If becoming a mature company was its only problem, Netflix would look like a bargain at its current share price of $209.09 as of the writing of this article, which is down 69% from all-time highs in November 2021. The company is profitable, and the GF Value chart shows the stock as significantly undervalued:
According to GuruFocus’ earnings-based discounted cash flow (DCF) calculator, assuming a discount rate of 9%, the company would only need to achieve a 10% earnings growth rate for the next decade to be fairly valued at the current level:
Unfortunately, Netflix seems determined to hasten its demise by driving away subscribers at a time when alternatives are plentiful and, in many cases, cheaper. What’s even more confusing is that the company is choosing this route despite acknowledging password-sharing likely contributed to its historical growth.
This part is just my own speculation, but perhaps the company is hyping up the “lost revenue” misconception in the hopes that in the short term, it can bring in more revenue from cracking down on password-sharing, helping the stock price recover. This could provide an opportunity for those with significant stakes in the stock to mitigate their losses.
Regardless of Netflix’s reasons for pursuing this strategy, I see it as the clearest sign yet that the streaming juggernaut will soon lose its dominant market position due to being out of touch with the reality of its situation. If the reason you’re losing subscribers is because you racked up the charges too fast and took an antagonistic stance toward customers, no amount of complaining about lost revenue or cancelling new content production is going to fix it.
