Netflix was the most high-profile story this results season, with shares dropping significantly after the company announced that it had lost more than 200,000 subscribers in the first three months of the year and expects to lose 2 million more over the next quarter.

While the Netflix story is itself fascinating, it also holds lessons for wider markets and especially technology stocks. Here are five key takeaways from the company’s first quarter results:

1. The cost of living crisis is underappreciated: Rising costs over recent months, well underway even before the energy price surge linked to the Ukraine conflict, mean that consumers have less disposable income. At the same time, wage inflation is not keeping up with rising costs, even if overall employment trends appear decent. Consumers therefore have to cut somewhere, and tech and digital subscriptions have not escaped the squeeze. Inflation has not been as transitory as hoped, and central banks may have no choice but to tighten monetary conditions, which could exacerbate that squeeze. The cost of living crisis is not going away, and consumers will continue to face tradeoffs: holidays and gourmet coffee or gadgets and subscriptions?

2. The COVID tech surge has waned: COVID-19 led to a massive rise in digitalization, directly benefiting many tech stocks. Following widespread vaccination, however, some “COVID winners” started to lose their luster. Many hyped-up tech stocks – such as Zoom and Peloton, for example – have come back to earth from their lofty earlier valuations. When this post-COVID tech softness ends is anybody’s guess, but the Netflix saga shows it’s clearly not over yet. Combine that that with the cost of living crisis and you have an especially potent cocktail.

3. Profitability matters: The tech sector, especially disrupters, benefitted in recent years as public markets began adopting approaches from private markets: paying for companies that can grow revenues rapidly, even if they are unprofitable or not cash-generative in the near term. For many such growth companies, it can be acceptable to spend to acquire users via incentives and build out their product suite. In that context, “buying” users makes sense given that valuation models are so dependent on growth. However, when growth weakens, valuation becomes an issue, especially with central banks changing the discount rate, which is also key to valuation. Consequently, business models and profitability matter more in this new era.

4. Spending big is no longer enough: Netflix spent some $17 billion on content in 2021 but still lost 200,000 subscribers in the first quarter of 2022. The company’s revenue run rate seems to be around $32 billion (assuming no growth versus Q2 2022), so there is less room to increase content spend towards management’s vision of $50 billion without user growth. Food delivery is another example where companies had to spend to gain market share, or expand their market segments, but the landscape is now getting tougher. Just Eat Takeaway, the European food-delivery leader, is planning to dispose of Grubhub just a year after acquiring the US food-delivery business. Other acquisitions made during last year’s heyday are also biting back. Teladoc, the telemedicine and virtual healthcare company, had to write off $6.6 billion relating to its recent acquisitions, such as the $18.5 billion buyout of Livongo, another virtual healthcare firm.

5. A new era for tech stocks: For the last 10 years, tech companies were winning through economic cycles as they rode multiple secular technology waves, such as digital adoption. Some market segments are now saturating, while competition is rising in many other segments. In this new era, even the mightiest tech companies will have to be more agile, adapt quickly and show discipline in their approach. Firms with weaker business models could face asymmetric downside risk if they disappoint, and startups are less likely to enjoy the bubble valuations seen in recent years. Fortunately, many mega-tech companies still have solid cash reserves, good business models and continue to invest in innovation.

The markets are now in the process of sorting out this new, post-COVID landscape marked by tighter consumer and corporate budgets, with a higher cost of capital. For both tech and non-tech firms alike, 2022 will be the year of the great reset. Investors are in for an interesting ride.

 

Written by Pinaki Das, Quintet Head of Thematic Research


Publié le 17 mai 2022