Netflix’s Other Achilles Heel: SAC

NEWS ANALYSIS – Netflix projects it will add 1.2 million domestic subscribers in the second quarter (ended June 30), which would give the SVOD pioneer nearly 58 million subs in the United States.

A conservative expectation – given Netflix’s market saturation – that will either be confirmed or denied July 16 when the service reports Q2 financial results. Netflix added 1.96 million subs in Q1 compared on a forecast of 1.45 million. Still, concern lingers among investors.

“Should domestic additions fall below last year’s 1.07 million level, we expect Netflix shares to decline,” Michael Pachter, media analyst at Wedbush Securities in Los Angles, wrote in a note. “Should guidance for Q3 net subscriber additions fall below last year’s Q3 additions (0.85 million domestic, and 4.45 million international), Netflix shares may react even more negatively.”

While missing its subscriber growth estimate would undoubtedly send Netflix bears and short sellers into a frenzy, a bigger concern is how much the service is spending acquiring new subs in the United States.

Netflix spent $228 million on domestic streaming in Q1, which was nearly double the $115 million spent in the previous-year period. That equals about $116 in subscriber acquisition cost (SAC) spent attracting each new domestic sub. Netflix spent about $81 for each new sub last year.

With the standard Netflix subscription plan costing $10.99 monthly, it will take the service more than 11 months to recoup the SAC spent acquiring each domestic sub in Q1. In other words, it is costing Netflix more to attract a dwindling new sub base.

By comparison, the service spent about $46 in marketing for each new subscriber outside the United States – up slightly from $44 spent during the previous-year period.

As many observers focus on sub growth, SAC and Netflix’s burgeoning content spend ($8 billion in 2018), the service’s free-cash-flow loss continues to grow exponentially as well. The company has projected a free-cash-flow deficit this year upwards of $4 billion – that’s on top of content spending!

“With declining domestic growth rates and spiraling acquisition costs, Netflix faces a very real set of challenges if it is to continue to command such a strong position,” Richard Broughton, research director at London-based Ampere Analysis, wrote in a note. “Our research shows that while Netflix can continue to enjoy relatively low acquisition costs for international subscribers and a buoyant market keen to embrace SVOD, it cannot afford to take its eye off the ball in the domestic market, even momentarily. Its ability to grow ARPU [average revenue per user] will be critically important to manage long term growth – domestically and abroad.”

 

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