26 April 2022
By Anna Macdonald, Fund Manager, Amati UK Smaller Companies Team
Netflix shares fell 36% after announcing its first quarter subscriber numbers had fallen for the first time – and more importantly forecast further falls to come in the second quarter. After a stellar 2020, and an impressive 2021, it seemed investors believed that the company could continue to walk on air. But the old chestnuts of growing competition, from incumbents and other newer kids on the block, and higher costs have affected even this poster child of the media and the pandemic. Is Netflix alone? No, other ‘pandemic winners’ are struggling to lap last year’s growth numbers, facing higher costs and consumer mean reversion to real, physical experiences cinemas, restaurants and face to face meetings. Just Eat announced on 20th April that costs are as elevated as ever, but customers churn and are expensive to attract, retain and re-attract.
Short term winners
How much further do the stars have to fall, and which ones have prepared themselves for a lower revenue, higher cost environment? The share price reaction to Netflix showed that even the most bearish outlook hadn’t expected such a fall in subscriber numbers, nor their comments that price increases would be hard to pass on. And expecting a further drop in subs, despite a strong slate in the second quarter which includes Stranger Things 4, is worrisome. The company might consider advertising to bring in revenue, as well as clamping down on sharing logins among family and friends. There’s nothing new to successful companies attracting others to the market and this in turn driving down margins. Nor is there anything new in rapid share price growth being followed by sharp falls, although given the huge number of retail investors the ramifications may be unusually widely felt.
Netflix’s woes may of course be just beginning. And the pandemic may have obscured what was already happening anyway. The ‘network affect’ of growing customers on the way up begat more growth as more was spent on content, which attracted more customers. For the first time a media company could personalise their display of TV shows and films and predict more attractive content for current and future subscribers. They could commit to huge budgets and commission talent for eye-watering sums. Despite having traditional levels of debt, Netflix also has ‘contingent’ studio and spending commitments (that don’t really seem that contingent) which equate to many more multiples of its earnings. If Netflix starts to cut content spend, can they keep and attract viewers? Viewers are being faced with a duplicity of choices, and other calls on their cash. Monthly payments to Disney Plus and Apple TV and Netflix and Amazon Prime, together with the increasing price of a broadband subscription, soon adds up, particularly if you have less time to spend watching all those shows.
Consumers are facing unprecedented increases in non-discretionary spend on utilities and food and housing costs. This hits the poorest hardest, and in times like this entertainment spend must be ‘good value’. For example, video games can offer several more hours of entertainment per hard-earned cent. Free to Air television could return to glory. For those fortunate ones who built up a savings ‘cushion’ during the pandemic, alternative calls on discretionary cash have appeal, such as taking a first holiday abroad since 2019 or a non-masked visit to a gym, pub, or theme park.
Streaming isn’t going away and is a permanent feature in the leisure and media mix, albeit with the spoils shared between others, some who have lots of IP (Disney, with its Marvel, Pixar, and original franchises) and those that have considerable distribution in place (Amazon).
Forging a new market
Are there industries that have found new and enduring customers? And which ones still have a competitive advantage? Video Gaming might just have forged a lasting bigger share of our wallets and our time. So far, Steam – the PC gaming platform - data shows that concurrent user engagement in January and February 2022 was 77% above levels seen in 2019. Total industry revenues in 2021 squeaked a rise of 1.1% to $180.3b on 2020 levels (which were an enormous 20% higher than 2019), driven by new console releases, more game play on mobiles and growth of cloud gaming (source: NewZoo).
The industry is attracting considerable levels of corporate takeover activity, with, according to Drake Star Partners, spend already at a record $86b in 2022 on top of $38b in 2021. The most notable are Microsoft’s $49b acquisition of Activision Blizzard, Take-Two Interactives’ $12.7b for Zynga and Sony’s $3.6b acquisition of Bungie. (Talking of Stranger Things, Netflix paid $65m for Next Games, who have worked on a Stranger Things game in the past – a foray into the world of videogaming for them, where only 5% of revenues yet are subscription based.)
The pandemic attracted many more players to video gaming, and it seems to have retained them. It’s not been plain sailing for publishers, however, as even the more established companies have had issues around glitchy launches (CyberPunk) as the pandemic disrupted sufficient quality assurance and testing. A crowded schedule has led to some disappointment in some releases – for example Frontier Development’s Jurassic World Enterprise 2 – the game was released on time, but the coinciding movie release was delayed by the pandemic shutdowns. In demand software engineers and developers have also been able to command rapidly increasing salaries. Keywords Studios, an outsourcer to 23 of the top 25 game publishers and 10 of the top 10 mobile publishers, generates just over a quarter of its revenues from game development. Whilst they see an ability to push wages through, salary increases are well ahead of inflation, at mid teen levels and above. This is something seen across the industry. So even if there is a more durable shift to gaming, and despite it offering, good value for the most part and increasingly social entertainment, costs need to be considered carefully, and from an investor’s point of view, the timing and capacity for passing on inflationary price increases.
The return of locked down leisure
Supported by furlough payments and generous rates holidays, sectors that were locked down have had the opportunity to regroup and assess their cost base and service proposition. Whilst this can be frustrating for consumers – as anyone who has tried to call an airline knows – there is vast potential for improvement and modernisation. Accesso Technologies is interesting in this regard. Accesso provides software solutions for ticketing and electronic queue management across a range of entertainment venues, with significant contracts with Six Flags and Merlin. Customers have come to expect access to information and payment by mobile phone for anything, and the provision of tickets, passes and refreshments at an entertainment venue is no different. These technologies also help leisure providers save on staffing costs at the venue and enable visitors to ‘make the most’ of their time – by queuing less you can ride more often and buy more snacks, drinks, and souvenirs. Other services – such as booking a haircut or ordering dessert – are being enthusiastically adopted by customers and business providers. Shopify, for example, delivers an end-to-end offering that means a small retailer can engage and fulfil their customers in a way that previously only a substantial enterprise and a big IT department used to be able.
Dogs, our companions for 15,000 years, had a ‘good pandemic’. Pets at Home’s share price more than doubled from March 2020 to September 2021. Investors liked that it provided veterinary care, accessories, and food to pets, at home. The labradoodle puppy from 2020 needed expensive vaccinations and weigh-ins during her first months, but now, fingers crossed, just needs walking and feeding for a good decade or more. The strategy to ‘monetise’ the customer base will likely require investment and can be eroded by other players, whether a supermarket or a local independent vet without an email list. Management needs to be nimble to respond to these shifting sands, – whilst managing increasing staff costs. When increasing numbers of us return to the office and are no longer WFH, the costs of care may also start to be a considerable burden to pet-owners.
And now, war.
Just as the pandemic may have masked competitive forces that already existed, the effects of Russia’s invasion of Ukraine and the continued clogging of supply chains, particularly owing to the approach to Covid in China, may obscure which companies are reacting well, or indeed which companies are well-positioned. Investors, when not grieving over the war, are nervous about whether they have called the winners and the losers right. They have a lot of factors to worry about, and a flighty market has led to some incredible volatility and some valuations that appear anomalous. If we can see a normalisation of much of customer behaviour but not a normalisation in supply chains, this will tend to favour companies that can deliver services that customers need, at reasonable prices, or those that they really want, like a family holiday.
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