I've been bored this afternoon, so I spent a little time digging through Netflix's annual reports to see if I can find an explanation for why a drop in subscribership cratered their stock.

Wanna see what I found? Too bad, you're gonna. (thread 🧵)

Let's start with a basic overview of their business. Netflix streams video content to paying subscribers over the Internet. In 2021, they brought in $29.7 billion in revenue. Streaming revenue accounted for 99.4% of that (the other .6% was DVD rental - yes, they still do that).

That sounds like a lot, right? But a comparison of their gross revenue (money that comes in) to their net income (money that's left after expenses) reveals that most of it goes right back out the door. Out of that $29.7B of revenue, they only held on to around $5.1 billion.

So where does all that money go? The vast majority goes to "cost of revenues," which is accounting-speak for money you had to spend to make money. For Netflix, that means licensing content and operating the infrastructure to stream it. They spent $17.3 billion on that in 2021.

Next question: how does a company that only nets $5B a year spend $17B a year on content licensing?

The answer is: they borrowed it. Netflix has spent the last decade borrowing like crazy. At the peak, in 2020, they held more than $16 billion in long-term debt.

And of course, when you borrow money, eventually you have to pay it back. Most of Netflix's debts won't come due until 2028, but starting then, they have some big checks they're going to have to write over the next few years.

You may have noticed that their debt obligations in 2028 & 2029 are in the $4-5B per year range.

In other words, they are going to have to make debt payments close to or equal the ENTIRE ANNUAL NET INCOME they make today.

And there is the thorn in the rose. For Netflix to comfortably be able to pay those debts back, it would ideally have significantly more net income than it does today. They could MAYBE make those payments with the income level they have today.

But if income goes DOWN? Gulp.

To increase income, Netflix has to increase revenue. And in their current model, the only way to increase revenue is to get more subscribers. They HAVE TO GET MORE SUBSCRIBERS to make their nut.

Which is why traders flipped out when they LOST 200,000. https://abcnews.go.com/Business/wireStory/netflix-shares-drop-23-loses-200k-subscribers-84174199

If Netflix's growth has peaked, they will have to find some other way to make those payments. A few options are obvious.

One is to cut back on developing original programming. Turning some of that big red "cost of revenue" slice back into net income could help a lot.

(But original content is what draws subscribers, at least in theory. So there's a Catch-22 here: you're not getting enough subscribers; you cut programming expense to cover the shortfall; now you're getting even fewer subscribers.)

Another option is to find a way to squeeze more money out of EXISTING subscribers. Which is probably why Netflix raised its subscription prices last month. https://www.theverge.com/2022/3/24/22993562/netflix-price-increase-us-plans-2022

And the final option is to find a way to make money off people who aren't interested in subscribing under the current model. Which explains Netflix's sudden interest in lower-cost, ad-supported plans, even though founder Reed Hastings famously hates ads. https://www.adweek.com/convergent-tv/why-netflix-may-add-ads/