Netflix stock is down – however it has a ‘problem’ its competitors would love to have
In three years, Netflix won’t exist. This was a bold prediction CHE Proximity’s Ben Shepherd recently heard, and one he says, is way off the mark. Here, he looks at what the numbers are really telling us.
The headlines this week all say one thing – Netflix shares drop double digits off subscriber losses. Read deeper and the market movements are due to net subscriber additions increasing 2.7m compared to forecasts of 5m.
Reports of Netflix’s demise are greatly exaggerated
To put the drop in context – in the previous three quarters Netflix added over 24m net subscribers.
The market reaction of an 12% after hours drop is interesting only for one reason – it provides a small opportunity to buy Netflix shares at a discount.
Ben, your colleague may be right – lots of competitors taking away some key shows. Have a read of this: https://www.forbes.com/sites/stephenmcbride1/2019/07/08/netflixs-worst-nightmare-has-come-true/#1307d9f5396d
Nice article Ben, however I will disagree with your sentiment that the 12% drop in the market provides a window to buy Netflix shares at a discount. This is one of the many market corrections Netflix has coming, and here’s why:
Being a disruptor, building a narrow moat and having a ‘monumental lead’ on any competitor works, but only for a limited time. Netflix has ridden the wave of being to first to market. However, the drop in Netflix’s biggest market (the US) off the back of a small price increase is indicative that Netflix’s subscribers aren’t as ‘sticky’ as they believed, and forecasted. Perhaps ARR is a metric we should be scrutinising in more detail, especially in the fickle world of free 30 day trials, the ease of creating a new email address and cancelling before the month rolls over.
The Office is the most watched show on Netflix. Friends is the second most watched show on Netflix. Who owns this content? NBC. Which company owned the top 3 biggest grossing movies at the box office in 2019 & 2018 & 2017? Disney. For years, these networks were willing to give Netflix their content, for a price. Now, these networks are pulling their content off Netflix and creating their own streaming networks. Expect to see a market that is not only awash with better capitalised competitors who actually own the IP to their content, but also one where consumers are heavily sensitive to price (as illustrated above in Netflix’s subscriber drop).
Netflix has produced cult shows – House of Cards, Orange is The New Black, Stranger Things, Mindhunter etc – but their ‘spray and pray’ content strategy of producing 95% terrible watching and 5% really great TV is not a strategy that will sustain the expected global subscriber growth or the business model. Content is not an investment. The more content Netflix produces, the worse the balance sheet is. Netflix has negative working capital deficit, long-term liabilities and no free cash flow.
So when we look towards the public market, Netflix is not a good investment. The market judges price on two things: growth and profitability. If Netflix’s growth story runs out of steam (and the growth story is only sexy for a limited time/CRs), the market will eventually look towards profitability and ROE, of which Netflix can’t sustain in its current business model. This is a wider trend we are seeing with the likes of Uber, Tesla, etc.
Debtflix will either have to re-adjust it’s business model drastically (read: introduce advertising beyond the very obvious product integrations they have in their own produced shows) or be forced out of the market by competitors. It might be in 3 years, but it’s coming.
Knows their shit!
Wall Street values Netflix at $US137 billion. Nine times net profit. On that basis, the market is very positive about its future.
Yes, market is positive about Netflix’s future at the moment, as we are taking into account Disney, HBO Max and NBC haven’t launched their own streaming platforms, or removed content from Netflix. Yet.
For the market to remain positive about Netflix in the next 12-24 months, we must assume 2 things:
1. Netflix doesn’t lose any subscribers (the main source of revenue) once the market is more competitive and audiences are given more choice in choosing what to watch and what content platforms to pay for.
2. Netflix continues to grow subscribers at a rate that not only enables the company to keep producing movie and TV franchises (and not any TV/movie franchises, we’re talking about content that keeps you subscribed and justifies a payment coming out of your bank every month) but also services the long term liabilities on the balance sheet.