Netflix borrowed billions of dollars to rise from movies-by-mail start-up to global streaming giant, splurging on content to tempt ever more viewers to its platform and reporting breakneck growth that sent its stock price soaring.
Now the strategy that has taken it to the commanding heights of Hollywood is starting to look more shaky.
The company has posted the first drop in subscribers in its core US market since 2011, when the company split off its DVD business and prepared the transition to online video.
Its shares closed 10.3 per cent lower on Thursday after it revealed it had lost 130,000 US customers in the second quarter. It was the worst day for the stock price in three years, wiping more than US$15 billion ($22.1b) from Netflix's market value.
The weak subscriber numbers could not have come at a worse time for the California-based company, stoking fears that Netflix is losing momentum just as Disney, Apple, HBO and NBCUniversal are ready to pounce with their own streaming services, which will launch in the coming months.
"Does it make us more nervous? Of course — especially given the timing of the Disney+ launch," said Todd Juenger, analyst at Bernstein. "If Netflix misses subs in the quarters after Disney+ launches . . . we expect the downside effect on Netflix stock will be several times more than usual."
The results also prod at the heart of Netflix's business model. The company has delighted investors despite burning US$3b in cash a year, promising that margins would improve as it hooked more customers and raised subscription prices, meaning it would no longer need to keep raising high-yield debt to fund its shows. This week's results have thrown that thesis into question.
Netflix raised prices in the US this year by as much as 18 per cent, a move cheered by investors. But the subscriber defections suggest demand is more elastic than executives thought. The price of a standard Netflix subscription now costs US$13 a month — a dollar higher than for rival Hulu.
While Netflix already has a strong grip in its home country, with more than 60 million Americans paying for a subscription, analysts have predicted that number could keep rising to as many as 90 million.
As recently as last month, media research group MoffettNathanson estimated the company would reach 88.4 million US subscribers by 2025. But on Thursday it warned "that scenario looks downright psychedelic".
"This one quarter calls into question many of those 2025 endpoints," said partner Michael Nathanson, adding that the results bring into question "Netflix's ultimate pricing power".
Netflix blamed the miss on a weak content offering during the quarter, without elaborating, and Reed Hastings, chief executive, had little in the way of explanation.
"It wasn't just one thing," Hastings said on an earnings call. "It's easy to over-interpret the quarterly [subscriber] adds, which are a bit noisy."
Netflix says the picture will improve as its flagship shows return with new seasons. The second quarter is usually Netflix's weakest, and the third brings the return of worldwide hits Orange is the New Black and Stranger Things, with The Crown to follow later in the year.
But the business is likely to become more challenging as the new wave of rival services looms. From November, Disney's streaming service will offer thousands of shows and films from popular franchises such as Star Wars and Marvel — at about half the price of a Netflix subscription.
In the next two years, Netflix is also losing fan favourites Friends and The Office, to WarnerMedia and NBCUniversal, respectively. The sitcoms are the number one and two most-watched shows on the platform, according to Nielsen. Netflix has brushed off the issue, arguing the losses would "free up budget for more original content".
The global numbers also disappointed. The 2.7 million subscribers added worldwide in the second quarter fell well short of Wall Street forecasts for 5.1 million new users.
Netflix's long-term debt stood at US$12.6b at the end of June, up from US$10.3b in March. It has forecast a free cash burn of more than US$3b this year, although it expects an improvement after that.
"In the meantime, our plan is still to use high-yield debt to fund our content investments," the company said, doubling down on its strategy to pump money into its own shows and films to further expand its 152 million global subscriber base. Analysts expect the company to invest US$15b in content this year alone.
Until now the company has remained a darling of investors. Although the threat of competition and the recent price rises amount to what JPMorgan analysts called a "wall of worry" around the stock, Netflix shares gained more than 35 per cent this year before peaking in May, compared with a 20 per cent rise for the benchmark S&P 500.
But observers are now wondering whether the golden age of Netflix is losing its sheen.
"Misses in subscriber numbers hurt Netflix shares more than just about any other metric, and this is a significant one," said Nicholas Hyett, equity analyst at Hargreaves Lansdown.
"Missing expectations just when competition for viewers is hotting up is doubly worrying and doubly painful."
Written by: Anna Nicolaou
© Financial Times