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.
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.
Looking at Netflix’s other metrics, it still remains a growth machine that is eating up the business models of many – especially the TV networks.
Q2 revenue was up 26% – to $4.92b USD.
Operating margin was up to 14.3% – an improvement of 2.5 percentage point year on year. Margins are improving despite some pundits claiming these will blow out as content rights increase in price.
It has forecast to market that it will add 7m net subscribers in Q3 – 15% up year on year.
My read is Netflix has navigated both a price rise, and the beginning of increased competition, and has come out of it 26% better revenue wise than it did the year before.
The drop in shares is the sort of over reaction we always see with digitally led businesses – with the inevitable recovery within 14 days.
Show me an entertainment business – ad supported or otherwise – doing these sorts of numbers and volume. Netflix still has significant growth upside in audiences over 55 and you would assume at some point it will look to tap into this. This is TV heartland and a huge source of volume in terms of consumption minutes. Tapping into this is tapping into the heart of TV.
I was on a panel last Friday and a fellow panelist delivered the hot take that in three years Netflix wouldn’t exist. I was equal parts shocked and equal parts impressed with this bold prediction.
However given the trajectory Netflix is on and the monumental lead it has on any potential disruptor – it felt like an unlikely scenario.
Ben Shepherd is the chief media officer at CHE Proximity. This piece was originally published on LinkedIn, and has been republished here with permission.
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
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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.
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Knows their shit!
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Wall Street values Netflix at $US137 billion. Nine times net profit. On that basis, the market is very positive about its future.
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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.
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