Reed Between The Lines. Hastings Had To Go.

The much-anticipated 4Q22 earnings call for Netflix, the first quarter that would encompass the initial results of its revised strategy embracing advertising, yielded the more startling news that its chairman and founder Reed Hastings was stepping aside, seguing to an “executive chairman” role after a quarter-century of building perhaps the most disruptive and transformational video delivery and production business of our lifetimes.

And on many metrics, while he’s not quite riding off into the sunset, he’s stepping down on a high note.  As the Washington Post’s Nina Masih objectively reported:

Netflix added 7.7 million new subscribers in the fourth quarter of 2022, beating forecasts and boosting its shares in after-hours trading.  In a letter to shareholders released Thursday, Netflix said the new subscribers were well over its forecast of 4.5 million. The growth was largely driven by the success of content added in the fourth quarter. TV series “Wednesday,” an Addams Family spinoff, was the company’s “third most popular series ever,” while documentary “Harry & Meghan” was a hit with audiences.

All well and good, ezcept while the subscriber projections were above expectations, revenue expectations were roughly on par, and projections for revenue per user were below what many investors had been led to believe were possible.  Given how successful Hastings had been over the years, there may have been reason for such optimism.   After all, Netflix essentially made the video rental business obsolete by offering a monthly subscription and the convenience of mailing DVDs to eliminate those endless Friday night schleps to Blockbuster and its mom and pop rivals only to find the porn cassette inadvertently (?) mixed in with the Total Recall box.  Larer, he topped that by making those titles available via high-speed internet, even eliminating the need to schlep to the mailbox.  And once they had their URL bookmarked for rentals of acquired content, they found a model to make a few high-quality series available as well, without commercial interruptions, for a modest fee.  And heck, we could even stream it to your phone and look fairly decent in the process,

But when you hace set the bar that high from your past accomplishments, even very good isn’t good enough in the eyes of a nervous investment community.  As Seeking Alpha somberly reported on the heels of yesterday’s results:

Netflix was one of the hardest hit names – both in terms of its fundamental and stock performance – during the 2022 market rout. Its lofty valuation premium, which ballooned during the pandemic-era run-up, buckled on souring investors’ sentiment, with the stock losing more than 70% of its market value in the first half of 2022 due to substantial churn, before paring losses to the 50% range following meaningful improvements in the second half. Netflix’s overall performance proved relatively resilient in the second half of the year, as post-pandemic churn gradually normalized. However, recent results continue to underscore maturing share in its most profitable regions like UCAN and EMEA. In UCAN, Netflix added less than 1 million new paid subscriptions in the fourth quarter. Although arresting declines experienced earlier in 2022, it appears Netflix’s strong slate of new premium content releases in the final quarter of the year did little to ensure outperformance in net subscription adds in its most profitable region from the prior year. But the segment’s revenue grew, nonetheless, thanks to resilient ARM growth as management had noted. EMEA experienced similar trends as UCAN when it came to net subscription adds, with a year-over-year decline despite sequential acceleration that arrested a first half paid net losses. But the region’s sales declined by close to 7%year-over-year given ARM decline of as much as 10% due to extreme FX challenges (ARM +5% y/y on a constant currency basis).

So with continuing co-CEO Ted Sarandos and his newly elevated partner in crime Greg Peters announced as those who will carry the battle on, the same investment community, apparently fans of Depeche Mode (they “Just Can’t Get Enough?:), noted that that battle looms to be especially difficult.  Sarandos and Peters, plus a truly talented team of executives, have lots of ideas of how to make things better.  They point to the evolution of Hulu over a 15-year span as a viable ad-supported streaming model that their global reach already dwarfs vs. their’s rivals U.S.-only footprint (Yes, their head of ad sales used to run Hulu’s).  They laid out plans to expand further into what they see as opportunistic ways to broaden the appeal and stickiness of their content, including gaming and fitness videos.  For the moment, Sarandos laid to rest any thoughts they may try to go after key sports rights the way Apple and Amazon, among others, have, with Sarandos wryly reminding “we like profitable businesses”.

But they face those uphill battles in a highly competitive environment, where much of the content that drove their earlier dominance now removed from its inventory, and a far savvier and economically pressured subscriber base than the one that they laid their foundation with with their seemingly endless stream of content being served up algorthymically, especially when the pandemic shut the world down and their willigness to let isolated families and friends from across the country share accounts become a lifesaving addiction.  Peters laid out more details of their plan to crack down on this, initially allowing users in the same household to maintain a common password and touting the success of their ad-supported tier, claiming the majority of those takers are incremental and not switchers.

Just offering different things on a menu to please different palates doesn’t necessarily mean you’re gonna get people to stay in YOUR walled garden to access it.  I was reminded of this while reluctantly giving in to exhaustion and rain last night and went through my first McDonald’s drive-through in years.  The last time I went, they offered a lot more variety.  At various times over the years, McDonald’s offered an array of reasonably healthy salads, even pizza, and at much lower prices, not to mention all-day breakfast.  Last night, the menu was much more limited, and the prices at least 25% higher than the last time I succumbed.  Yes, I bought in this time, but I’m not likely to come back any time soon.

So imagine how difficult it will be for to acquire someone who may have been an early adopter of Netflix, but never became a subscriber under the all-you-can-eat-for-one price banner?  Will they be willing to forego their Beachbody accounts for Netflix’s fitness models?  Will they leave XBox for Netflix’s games?  Can Netflix be expected to have the success rate that investors are expecting in order to offset the development or acquisition costs necessary to broaden these businesses?  And will their average subsciber level be consistent enough with which to sell advertising flights on when their release model is still heavily oriented toward binginess, and there simply aren’t enough new and noteworthy shows being introduced often enough to give people a reason other than lethargy to hang around?

My consumer research friends have been doing a lot of qualitative work in this space lately, and they freely share their surprise when they hear even middle-aged and older consumers expectionally savvy about how to beat the system with one person in a friends and family group having one subscription and sharing them with others–seven different services’ costs spread out one to a person.  Or people setting reminders to opt out of a service soon after they see whatever flavor of the moment show they want to see.,

Even if Hastings or his subordinates won’t admit it publicly, I’m pretty sure they have conducted similar work, or at least seen results from suppliers seeking their business.

And as Inc.’s Jason Aten somberly observed, perhaps Hastings himself knows exactly what lies ahead: