Just a few months ago, it looked like the COVID-19 pandemic had kicked Netflix‘s (NASDAQ:NFLX) growth into overdrive. In the first half of 2020, the video-streaming pioneer’s paid subscriber total surged by nearly 26 million. That was more than double the number of paid net additions from the first half of 2019.
However, Netflix’s subscriber growth came back to Earth beginning in May. Netflix is still on track to report strong membership growth in 2020. But the fact that the pandemic provided only a limited short-term boost to its growth rate raises the question of whether the company has entered a new period of perpetually slowing growth.
Subscriber growth misses expectations
Three months ago, Netflix projected that it would add 2.5 million paying subscribers in the third quarter, compared to 6.77 million in the prior-year period. Management attributed the slowdown in subscriber additions to growth having been pulled forward into March and April (the peak of the shutdown phase in many countries).
On Tuesday, Netflix reported that it actually added just 2.2 million new paid subscribers last quarter. During the earnings call, management said that was a trivial deviation from its guidance and reminded investors that it strives for accuracy (not conservatism) in its forecasts. However, many analysts and investors had thought Netflix was being conservative, so the actual result seemed disappointing. As a result, Netflix stock fell 7% on Wednesday. That still left it up more than 50% year to date.
For the fourth quarter, Netflix projected that it will add 6 million paid subscribers. If that guidance proves accurate, full-year paid net additions would be 34.1 million, compared to 27.8 million in 2019 and 28.6 million in 2018.
Digging into Netflix’s growth rate
Adding 34.1 million paid subscribers in a year would be a remarkable accomplishment for Netflix. Yet in percentage terms, it would represent subscriber growth of 20%: in line with the streaming giant’s 2019 growth rate and a good deal slower than its 2018 subscriber growth rate of 26%.
Netflix’s management frequently talks about competing with a wide variety of other activities (e.g., video games) for consumers’ time. From that perspective, Netflix has never faced less competition than in 2020. Numerous in-person entertainment options have been closed due to the pandemic, and many people don’t feel comfortable with those options that are still available. All in all, the amount of time people have available for consuming TV entertainment has been uniquely high in 2020.
With that in mind, the fact that Netflix was only able to match its 2019 growth rate in percentage terms highlights how the streaming giant is saturating many of its markets. In the U.S. and Canada — its most mature markets — Netflix has increased its paid subscriber count by just 9% over the past year, despite the big tailwind from the pandemic.
In the EMEA (Europe, Middle East, and Africa) region, Netflix isn’t as mature, but its paid subscriber growth has slowed to 31% over the past four quarters from 37% in 2019 and 45% in 2018. Netflix now has over 62 million subscribers in the EMEA region, compared to 73 million in the U.S. and Canada. EMEA’s addressable market is bigger, so there’s clearly room for further expansion, but without the benefit of the pandemic boosting demand for at-home entertainment, growth in this key region is likely to slow dramatically.
In Latin America, Netflix is adding subscribers at an even slower pace than in Europe. The Asia-Pacific region is the only part of the world where subscriber growth still exceeds 50%. However, that’s Netflix’s least mature region and smallest by revenue. There’s clearly a lot of room for growth there, but whether it will be enough to carry the whole company is far from certain.
Is this as good as it gets?
Netflix’s management suggested that net paid subscriber additions will probably return to the levels seen over the past two years in 2021 — i.e., about 28 million per year. That implies a slowdown in subscriber growth to just 14% next year. I expect it to slow further in the following years, as it will be increasingly difficult to add new subscribers in the saturated U.S., Canada, and EMEA markets.
Don’t get me wrong: Netflix still has plenty of growth in its future. But that growth is going to come at a slower rate than what investors have experienced over the past five years. Meanwhile, even after falling on Wednesday, Netflix stock trades for about 55 times the company’s projected 2021 earnings. With many of the company’s biggest markets set to approach saturation over the next few years, that earnings multiple seems a bit too generous.