Now We Know Why Netflix Is Trying but Failing to Go on a Shopping Spree

As the world's largest premium streaming service, it seemed odd to see Netflix (NASDAQ: NFLX) tied to so many potential content acquisitions over the past year. After Thursday afternoon's poorly received financial update, it's becoming clear that it is despair -- and not greed -- driving the push for non-organic growth.

Friday morning saw at least one analyst downgrade and eight price target reductions, even a couple of hours before the market opened. Netflix's second quarter wasn't great. Its near-term guidance was worse.

Let's reassess Netflix's public and, in some cases, heavily rumored M&A activity in light of the platform's slowing growth.

Channel surfing for growth

Netflix stock has plummeted more than 40% over the past year, so it's fair to say that it was already struggling to connect with investors even before this week's update made matters worse. The second quarter was a mixed bag. Revenue rose 13.4% to $13.56 billion, its weakest year-over-year growth in more than a year and just shy of $13.57 billion that it was modeling three months earlier.

Net income expanded to $0.80 a share, just ahead of the $0.78 a share it expected and the $0.79 a share analysts were targeting. After falling short on the bottom line of Wall Street pro estimates in two of the three previous quarters, it was good to see a bottom-line beat.

Looking out to the third quarter, the top line is only going to get worse. Netflix's fresh forecast calls for $12.86 billion in revenue for the third quarter, an 11.7% step up from the prior year. If this is where Netflix lands, it will be its weakest top-line growth in three years. It sees rosier bottom-line growth, with its operating margin expanding, but revenue growth is pulling the focus away from its improving profitability.

A classic growth stock is becoming a value stock

The revenue slowdown isn't a historical nadir for Netflix. The platform's top-line growth slowed to the mid-single digits in 2022 and 2023. However, it could explain why Netflix made a brazen -- and initially successful -- bid for Warner Bros. Discovery (NASDAQ: WBD). It has also been tied to other content creators and streaming platforms on the block.

Netflix needed to be fixed up because the platform itself needs fixing. While it remains globally popular, gaining global market share of the time folks spend watching TV, it's making a big push to expand into live events, short-form content, and video podcasts. Netflix wants to be the one-stop solution entertainment and escapism platform for its still-growing user base.

However, last week, Netflix began retesting free-trial eligibility for non-rejoining new members in several countries outside the U.S. and U.K. markets. Another sign that organic subscriber growth may be slowing is chatter that it is considering a free, ad-supported tier with limited content in some territories.

"A free offering could make sense in some markets, but we have to be thoughtful about cannibalization of paid tiers," Netflix said during its earnings call on Thursday.

This won't make investors happy, even though Netflix did point out that a near-term launch is not imminent. It's merely a matter of considering what a free option would look like. It's not the look that growth investors can appreciate, but the stock's recent retreat as its profitability expands could be a dinner bell for value investors.

Friday morning's initial price drop leaves Netflix with a forward earnings multiple in the high teens. Looking out to next year, the ratio drops to the mid-teens. Analyst profit targets are likely to drift lower until the situation stabilizes, but the valuation argument is stronger than it was a year ago.

Netflix isn't shopping to create a distraction, even though that theory certainly makes sense given its slowing revenue growth and cascading share price. I would argue that Netflix is eyeing acquisitions because it wants to be more than what it is right now. It can't be everything for everyone organically, so it's going to have to cut some checks. Given its falling share price, don't be surprised if those checks now have to be made out to cash rather than equity.

Rick Munarriz has positions in Netflix. The Motley Fool has positions in and recommends Netflix and Warner Bros. Discovery. The Motley Fool has a disclosure policy.