Why Web-Based Stocks Are So Sensitive To Subscription Growth

Includes: ACOM, GRPN, NFLX
by: BubbleBustInvesting

Of all misses investors won't forgive, one stands out: A slowdown in subscription growth. Remember when Netflix (NASDAQ:NFLX) reported a decline in its subscription growth last summer? The stock tumbled from low $300s to low $60s as investors headed for the exits, but they did come back as growth resumed two quarters later. Now, as the company reported a slowdown in subscription growth, investors are heading back for the exits - though the company reported better than expected earnings.

This pattern has been observed in other web-based companies. When Groupon (NASDAQ:GRPN) reported a slowdown in its subscription growth last week, its stock skidded too. Ancestry.com's (NASDAQ:ACOM) stock had a similar fate this week when the company reported a slowdown in its own subscription growth rate - though it reported better-than-expected Q4 earnings. What's going on? Why are the stocks of web-based companies so sensitive to subscription growth?

Here are some explanations:

  • First, subscription growth determines the pace of revenue growth, and a slowdown in revenue growth is rarely a good thing for any company, especially for young companies.
  • Second, a slowdown in subscription rate is usually perceived as a weakening in the company's competitive position, as it is followed by a decline in market shares.
  • Third, a slowdown in subscription growth may raise the acquisition costs per subscriber, hurting the company's bottom line.
  • Forth, a slowdown in subscription rates makes it increasingly difficult for the company to achieve "economies of networking," the benefits associated with more and more users joining the network, as we have discussed previously.

The bottom line: Subscription growth can make or break web-based companies. Investors should keep a close eye to it before buying shares of these companies.

Disclosure: I am short NFLX.

Additional disclosure: Active trader; may change positions at any time