As Netflix shares were falling in Friday trading, there need not be any more confirmation of this market's worship at the altar of growth. Netflix management's prediction of net subscriber growth of only 2.5 million in the third quarter was enough to take the shine off the Netflix story. This at the same time that Netflix actually delivered positive free cash flow for the second consecutive quarter and predicted a flat-to-positive result on FCF for full-year 2020.
How dare you! How dare you focus on internally funding your business instead of chasing every last subscriber? The thing is, Netflix didn't make any strategic changes in 1H2020. The pandemic did it for them. Covid-19 locked down production on most of Netflix's original programming and therefore spend declined. So, Netflix's positive free cash flow in the quarter was really an effect, not a cause.
The real problem for Netflix is competition. Covid-19 and the accompanying stay-at-home governmental edicts let the streaming genie out of the bottle. While Netflix's shareholder letter mentioned WarnerMedia, NBCUniversal (CMCSA) and Disney (DIS) as legacy content-based new streaming competitors, and Apple (AAPL) and Amazon (AMZN) as tech competitors that have moved into content, the real reveal was in the second sentence.
In addition, TikTok's growth is astounding, showing the fluidity of internet entertainment.
Yes, TikTok. The Covid-19 shutdown has unleashed this Chinese content dragon on the world. With TikTok's parent ByteDance having hired senior Disney exec Kevin Mayer (he's TikTok's CEO and ByteDance's COO), this company has gravitas at the top. TikTok has generated not millions or billions but trillions -- my ForYou page is showing 2.55 trillion in total -- of views. The U.S. government may not like it, but TikTok's reach is undeniable.
I was asked to explain TikTok to a person only slighter younger than I am the other night. I could not do so. I was, however, able to answer the question "do you have to dance in TikTok videos?" with an emphatic "no." My friends do dance, occasionally, in their videos, however, because if they didn't dance they would not be friends of mine.
TikTok has revolutionized video entertainment. There is no greater proof of this than the first video on my ForYou page. All week it has either been an ad for content from Apple or for Beats headphones, which are owned by Apple. That's the mark of disruption. It's not when your competitors attempt to beat you, like Facebook's lame attempt to ape every other competiing technology including TikTok via its Lasso feature, which has been canceled, and the upcoming Instagram Reels. No, it's when your competitors are so awed by your numbers that they start paying you to broadcast them.
When I first saw a Netflix commercial on broadcast TV, I said to myself "these guys -- legacy broadcasters -- are in trouble." Now I look at Netflix, with its steadfast refusal to accept advertising, and see that that business model is under threat. The disruptor is being disrupted. If two quarters of positive cash flow -- Covid-19 driven or not -- from a company that seemed positively allergic to self-funding is not proof, then nothing is. As if to reassure investors, though, Netflix management did note last night that 2021 free cash flow is expected to return to negativity, although not at 2019's burn rate of $3.3 billion.
It's a wacky world we live in. Cash burn is taken as a source of pride in some sectors of Silicon Valley. But growth is measurable, and yesterday's earnings report was a flashing red light that Netflix's growth is slowing.
Change happens when humans change behaviors, especially those most unlikely to do so. For instance, as even further evidence of the craziness, I have started a TikTok page. I don't have many followers there, but I do pithy recaps of all my articles, so if you want to follow me, you can do it here.
Change is happening. Investors who miss the disruption, even of entities that were formerly disruptors themselves, always end up poorer.