Here’s Why Netflix Can Shrug Off its Stock Plunge

It’s not every day that a brand-name stock loses a quarter of its value in a matter of minutes, as Netflix did after reporting its financial earnings Wednesday. It’s even rarer when executives respond as if it’s no big thing.

After Wednesday’s stock market close, Netflix reported a net profit that exceeded Wall Street’s expectations. So far so good. But Netflix’s success hinges on whether it can keep signing up new subscribers, and it’s here where the company came up short: The company added 3 million net subscribers around the world after publicly predicting it would add 3.7 million.

Investors read those numbers and started running for the hills. It took about 30 minutes for Netflix’s stock price to fall by more than $120 a share. After the plunge, the company was more philosophical than apologetic. “Our internal forecast . . . will be high some of the time and low other times,” CEO Reed Hastings shrugged in a letter to shareholders. Later, on a Google Hangout with select analysts, he was just as Zen-like, saying he expected to miss subscriber estimates “frequently.”

There are a few reasons why Hastings can get away with this attitude without investors calling for his head. Wednesday’s stock market was a tumultuous one in general, seeing the Dow close down 173 points after a 458-point drop at its worst. And amid lingering concerns that tech valuations in general were too high, many investors were ready to sell any stock on bad news.

On top of that, Netflix has long been a favorite of speculators, who have made it one of the most consistently volatile issues in the tech sector for the past decade. This has long been a headache for Hastings, who’s complained before about “momentum investor-fueled euphoria.” Such euphoria usually ends in nasty hangovers, like the 80% plunge in Netflix’s stock price after it raised prices in 2011. What Netflix is seeing today is another bender coming to an end, one Hastings predicted a year ago.

The main reason Netflix is shrugging off the current decline is that the company has always hewed, come what may, to a single strategy of finding a more efficient way to distribute video content. That tactic, which has always worked out in the long run, is the classic distrupt-the-incumbent model. And in the world of video content, no one has done this better, and more consistently, than Netflix.

The creation myth of Netflix says that Hastings founded the company after racking up $40 in video rental late fees. As DVDs emerged, Hastings started delivering them by mail, precipitating the slow but sure extinction of video-store giants like Blockbuster. As bandwidth improved, Netflix switched to an even more efficient way to deliver movies: by streaming them online. Today, 87% of Netflix revenue comes from streaming movies and TV shows. Netflix has effectively disrupted its own founding business model. Netflix wasted no time disrupting its founding business model, splitting off its DVD-by-mail business into an ill-fated venture called Qwikster. Today, Quikster is an unsightly footnote in the company’s history, and 87% of Netflix revenue comes from streaming movies and TV shows.

More recently, Netflix has begun to bump up against the cable companies that are so loathed by consumers by pushing more into TV programming, notably several of its own series. In a victory for cord-cutters, Time Warner said Wednesday it would offer HBO as a standalone online service starting next year. That will provide Netflix a strong competitor, but it’s likely to do more damage to the cable providers in the long run. In effect, HBO is hedging its future by adapting to the model Netflix pioneered. CBS followed suit Thursday with its own launch of an on-demand subscription service for its programs.

Now Netflix is moving into a new area by producing its own original films, reasoning that it’s often cheaper than entering into bidding wars for titles every several years. This is likely to work with “branded” films, like a sequel to Crouching Tiger Hidden Dragon and a series of Adam Sandler vehicles (Netflix says data shows Sandler’s comedy translates well in global markets like Brazil and Germany — who knew?).
This latest move is angering movie theater chain owners, mostly because their own aged business model has turned into another unpleasant experience for consumers. Moviegoing often involves paying upward of $15 a ticket to endure a gauntlet of pre-film commercials and obscenely overpriced popcorn. Another recent technological development, the rise of affordable, high-def home entertainment systems, is making it easier to bypass that experience. And Netflix is now working to speed up the time it takes for new movies to reach home theaters.

All this is costing Netflix a lot of money. Streaming content obligations rose to $8.9 billion from $7.7 billion in the last three months alone. Netflix is warning that these obligations will weigh down cash flows for years. This is risky, because the new content costs may not translate into enough new subscribers. And that’s why investors freaked out about the low subscriber figures this quarter. Netflix keeps building more content, but what if subscribers don’t come?

Right now, Netflix is shrugging in the face of all this fretting. Investors also worried two years ago, when the company’s overseas operations were losing $400 million a year. This year, Netflix’ international subscriptions are close to breaking even. Most of all, the company has learned to ignore speculators and naysayers as it pursues its core strategy of finding better ways to bring quality video content to consumers. Producing movies may sound like a new and risky area to move into, but as Netflix sees it, it’s the same old business model that’s worked so well in the past.