Netflix (NFLX) released their 2020 Q3 earnings last week. Here are some of the high level numbers:

• Revenue of $6.44B (up 22.7% year over year)
• Net subscriber additions of 2.2 million vs. forecast of 2.5 million
• Q4 guidance of 201.15 million global streaming paid memberships (an increase of 20.4% year over year)

The market apparently wasn’t very impressed by the miss on subscriber additions, as the stock is down around 8% since earnings came out. I honestly thought it was a pretty solid quarter, considering they had warned us about all of the subscribers that had ben pulled forward due to Coronavirus. Taken as a whole, this year has been a pretty stellar one for subscriber growth. However, I do believe this most recent quarter might be showing us that Netflix is a company in transition.

Previously, when I was judging how Netflix was performing as a company, it was almost solely on their ability to grow and gain new subscribers. A common criticism of the company was that it was spending too much money but I was willing to excuse that as long as the subscriber count kept growing at a brisk pace, and it did. And while subscriber growth was still pretty great this year thanks to international markets and the pandemic, I believe we’re starting to see signs that the days of stellar growth are beginning to come to an end.

Netflix breaks their numbers down by 4 regions. Here is the subscriber growth over the past 4 quarters by region:

• UCAN (United States and Canada) – Up 8% y/y
• EMEA (Europe, Middle-East and Africa) – Up 31% y/y
• LATAM (Latin America) – Up 24% y/y
• APAC (Asia-Pacific) – Up 62% y/y

As you can see, subscriber growth in its most mature markets (United States and Canada) was pretty slow. And while growth in the EMEA and LATAM regions was strong, the real superstar was APAC. In fact, the APAC region was responsible for 45% of new subs in the most recent quarter. With the United States pretty much saturated and Europe/Africa/Latin America unlikely to see growth acceleration, it is looking like the Asia-Pacific region is going to be relied on for much of Netflix’s future growth. With 60% of the world’s population, that doesn’t seem like a terrible place to be.

However, I do wonder if the Asian market might be the toughest fight for Netflix yet. They don’t have the streaming video market to itself anymore, and the competition is either already established or charging hard. China has a number of incumbents like former Freedom Portfolio holding iQiyi (IQ) and Netflix has never been able to really make inroads there. India is promising, but Disney (DIS) already has somewhat of a head start by virtue of their ownership of Hotstar and its 300 million active users. Netflix has had to introduce cheaper, mobile-only plans in India in order to gain traction there, which is part of the reason why their average revenue per user (ARPU) is lower in Asia than it is in other markets.

That brings up another concern: pricing power. For awhile, Netflix enjoyed tremendous pricing power as the only game in town and many people talked about how much of a deal it was (especially compared to traditional cable bundles). That’s no longer the case. Cable cutting is accelerating, which lessens the impact of that comparison. Netflix has started to lose some of its most popular programming like The Office and Friends. Disney has launched their competing offering at a much lower price point to gin up interest. There are even fairly compelling free competitors like Peacock. It’s hard to envision Netflix being able to significantly raise its prices anytime in the near future in the face of such competition.

It’s absolutely not all doom and gloom, however. As I mentioned earlier, Netflix is a company in transition. So if it is transitioning away from growth, what is it transitioning to?

Positive free cash flow!

Partially due to production of new content being shut down, the company has actually reported three consecutive quarters of not just positive free cash flow, but increasing positive free cash flow. Netflix is beginning to show its critics who were concerned over its spending and debt that it can make money once it decides to slow down on spending. And with over $8 billion in cash on the balance sheet, they don’t even expect to have to raise any capital this year.

I don’t expect the increasing free cash flow to continue as production that has been shut down due to Coronavirus starts back up, but it is encouraging to see what Netflix’s second act might look like once it has fully transitioned away from subscriber growth at all costs.

All of that is a long-winded way of saying… I’m trimming my Netflix position some, and using the proceeds to add to my Etsy (ETSY) and Crowdstrike (CRWD) positions. I still think Netflix is a wonderful company with a lot of growth ahead of it, and I am still holding the majority of my shares (keeping it at a Serenity level position), but I just think its growth prospects have dimmed a tiny bit.

I haven’t really done much with P.A.U.L. scores lately, but I thought it was worth revisiting what I wrote about Netflix when I scored it back in October of 2018. Back then I gave them a 4 for “Long Runway”, which I would probably bump down to a 3 now, but the biggest drop might be the “Alternatives” score of 5 that I had previously given them. Netflix started off as a DVD by mail company which then disrupted itself by transitioning to online streaming and finally reinventing themselves again by moving from licensing content to developing their own. Now that they are in the midst of conquering international markets… what is their next step? Previously, I was confident there would be one. Now, I am not so sure. There might not be a next chapter for Netflix, and founder and CEO Reed Hastings stepping back somewhat into a co-CEO role with Ted Sarandos might be a symbolic way of showing that the company has reached maturity.

Netflix is probably the company that I have the longest history with, having originally bought shares all the way back in 2004. And every time in the past that I have sold my shares of Netflix, I have regretted it. As I’ve mentioned more times than I can remember, the initial bunch of shares that I bought almost two decades ago would have been worth roughly $2 million now if I had just held onto them. That’s an eye opening lesson. It’s not just shares bought a long time ago either. Most recently, I sold some shares of Netflix last July at around $328 a share. All it has done in a little over a year since is go up 50%. I think there is a very, very good chance that I will end up regretting this sale as well. If that happens, it won’t be the worst thing in the world as I will still have the majority of my position.

I want to be very clear that even though I am trimming my position some, I still think Netflix has a ton of growth in front of it and I’m still a big believer in it being an outperformer over the next 5+ years. I’m just not quite convinced it has the same levels of upside that it did before. Time will tell.