The first blood of the streaming wars was shed in Netflix red. Last quarter, the company reported a miss on international growth projections (2.8m vs 4.8m net new subscribers) and announced the loss of 126,000 paying US subscribers – a first for the streaming pioneer. In their 3Q19 earnings call later today, we expect eyes to be fixated on screens when we get another commercial-free report from the company at 6:00 PM EDT.

Going Back a Few Episodes...

We took a look at Netflix with the Amenity NLP toolkit to paint an objective picture of the company’s storyboard and found a drop off in positivity around key financial commentary and elevated deception – perhaps the makings of a blockbuster drama, if only there was a Netflix-enabled TV remote in reach!

Management blamed lacking performance on subscriber sensitivity to price hikes, a lack of compelling content in the pipeline, and the frontloading effect of having outperformed earlier in the year. Sample extractions detected in the 2Q19 call illustrate the point:

• "...in regions where we increased prices, we did see some elevated churn rates and lower retentions. So it was a combination of those two things."
• "...the slowdown in subscriber growth was across all of our regions. So you talk about our kind of top of funnel or gross adds, we saw that slowdowns across the board, which indicates to us some level of seasonality and kind of the overall, as we say, the kind of timing of the content slate."
• "...while there may be some short-term slowdown in subscriber growth because of pricing, that increased revenue is very good for our business and ultimately for our members..."

Netflix’s Amenity Score, which we calculate as a representation of the overall sentiment in an earnings call related to a company’s fundamentals, unsurprisingly tanked (see Figure 1). Netflix shares sank 11% immediately after the 2Q19 earnings call and currently trade about 20% below the pre-earnings close. Should the miss and loss have been a surprise? Is there cause for further concern going into the 3Q19 earnings call? Amenity’s NLP models help to distill and contextualize Netflix’s strategic outlook. (Spoiler alert: we saw this coming… #foreshadowing?)

Figure 1: Netflix's Amenity Score Over Time

Looking back at extractions that Amenity’s models captured in Netflix’s 1Q19 earnings call, we observe Eric Sheridan of UBS asking CFO Spencer Neumann a question that perfectly encapsulates the issues that materialized the following quarter. Neumann’s answer included three detected extractions, two of which we classified as deceptive. Snippets from the exchange are provided below:

Question (Eric Sheridan, UBS):

• "...talk about the building blocks of the way in which you’re framing the subscriber growth going forward in Q2, the price increases that are going through a number of jurisdictions, what that means for ARPU, what that means for churn so investors can better understand that."

Answer (Spencer Neumann, CFO):

• "... There’s definitely some seasonality to our business, which we see in Q2. You see that again this year. But I’d say, in general, our paid net adds are very much in line with what we’ve been planning and targeting for the year… There’s just some temporary churn that enters the system in the midst of rolling out those price changes. But that’s why you see more of the net adds weighted to our international segments in Q2 but overall very healthy, going according to plan and very strong growth for the first half of the year and putting us on track...for another year of record paid net add growth for the full year."

Hindsight is 20/20, so we know where those particular chips landed… Rewinding the tape further, we find additional evidence to substantiate concern about Netflix’s decision to raise prices in the 4Q18 earnings call. Sample extractions below illustrate the point:

• "...this is one of those relatively infrequent moments where as we invest more in the service … we occasionally go back to our subscribers and ask them to contribute a little bit more..."
• "...in the US, we -- for the first time, we increased our entry-level pricing, and the overall blended price increase was a bit -- as a result, a little bit more significant than last time around."
• "... our focus in terms of capital allocation and getting smarter and smarter about how we allocate our content dollars in programming mix and in partnering with Ted and the team and continuing to invest in the product and the experience with Greg and his team. So that’s what we’re most focused on and then helping to continue to scale our company."

Whether these were adequately loud warning calls of the consequences of a pricing shift, we take comfort in knowing that our models successfully identified these extractions as significant for the fundamentals of the business. Coming back from our trip down memory lane, we look forward to today’s earnings call so that Netflix can address the concerns of analysts and investors alike.

Thinking Ahead...

Last quarter, management spent noticeably little time crediting the increasingly competitive streaming landscape for its performance woes. We imagine this may come up today given the range of taggers on that have put major resources into their streaming products. It looks like lots of folks are coming for Netflix’s lunch. Amazon, Apple, Facebook, Disney+ (targeting an always-growing-up audience), NBCUniversal (whose Peacock service scooped up rights to The Office from Netflix), and HBO Max (which is, ironically, poaching Friends from Netflix) are all poised to take share as their offerings come to market. We’ll be lasered in on how Netflix responds to tough questions about the competitive threats and get back to you with our analysis.

Management’s stated solution to the competitive threat has been to double down on content investments while swatting away rumors of pivoting away from a single stream revenue model. Netflix continues to say it will never run advertisements, but we are left to wonder... How can we consider buckets of KFC strategically located inbounds of our Stranger Things episodes as anything but advertisements?

Popcorn to go with the show...

If you own Netflix shares and have yet to tune in for an earnings call, you are not alone. We were surprised to learn that Netflix doesn’t actually have conference calls. Instead, the company hosts an “earnings interview” in which one of about 40 analysts that cover the company gets to ask questions of key executives. While the last interview was conducted by Michael Morris of Guggenheim, we find it curious that Eric Sheridan of UBS was the analyst invited to participate for the previous three calls in a row. (The irony is not lost on us that Netflix, the streaming giant, hosts its earnings call videos on YouTube…)

What exactly do the thirty-something other analysts do with themselves in the meantime? We suggest heading to Netflix for an episode of Friends before they disappear. #TheOneWhenNetflixReportsEarnings

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‍About Amenity

Amenity Analytics is the industry leader in providing insights from unstructured text by using Natural Language Processing (NLP) assisted by Artificial Intelligence (AI) and Machine Learning (ML). Amenity’s NLP system is a sector-agnostic, language-dependent tool for quantitative text analysis that is deployed across the financial services industry and beyond.

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This communication does not represent investment advice. Transcript text provided by S&P Global Market Intelligence.

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