You may well be right, AIA
Quote:At this point, I think it’s hard to ignore all the red flags in Netflix’s fundamentals and valuation. Here’s a list of all the reasons why Netflix will struggle to justify its valuation. Netflix is in the Danger Zone.
Content Spending Not Adding Enough Subscribers
Netflix’s biggest problem is that it’s paying more and more to acquire new subscribers. Marketing and streaming content spending has risen from $308/new subscriber in 2012 to $581/new subscriber TTM . Meanwhile, revenue and subscriber growth is slowing. As I showed in “Netflix’s Original Content Strategy Is Failing”, the company’s incremental expenditures each year are ~50% higher than its incremental revenue.
Rising customer acquisition costs make it hard to see how the company reverses its trend of negative free cash flow.
Despite Netflix’s heavy spending on original content, shows and movies licensed from 3rd party studios continue to drive the majority of the company’s viewing hours. Netflix does not release its own viewing data, but numbers from analytics company 7Park Data suggest that, as of last fall, licensed content accounted for 63% of viewing hours on the platform.
That same data also showed that The Office and Friends are two of the three top-streamed shows on Netflix. As I wrote about in “Loss of Licensed Content Is an Underrated Crisis for Netflix”, Netflix doesn’t appear to have a plan in place to replace these beloved shows when they depart the service in 2020 and 2021.
Benioff & Weiss Deal Reeks of Desperation
Netflix’s latest strategy to spend big bucks (and burn more cash) to sign up big name writers and producers to create original content for the platform is risky. Most recently, the company signed up Game of Thrones showrunners David Benioff and D.B. Weiss to a reported $200 million deal. Speaking to CNBC, New Constructs CEO David Trainer said this deal “reeks of desperation.”
Looking at the facts, it’s hard to see how the Benioff and Weiss deal can generate value for Netflix. The screenwriting pair have little goodwill from fans after the final season of Game of Thrones (GOT), and they don’t exactly have a huge track record of hits outside of the HBO adaptation of GOT. Plus, they’re already signed on to produce a new Star Wars trilogy for Disney (DIS), so it’s unclear how much time they’ll have to devote to Netflix shows in the near future. Netflix appears to be falling victim to “The Overvaluation Trap” and feels the need to swing for the fences in order to attempt to justify its inflated valuation. While these high-profile, fashionable deals may get some headlines, we think they will destroy shareholder value over the long-term.
Pricing Power Evaporating
Pricing power has long been one of the major bull cases for the stock. By this argument, the company is keeping its price low now to attract new customers, but the service is sticky enough that they’ll be able to raise prices in the future.
This bull case doesn’t stand up to scrutiny. Streaming services actually face relatively high churn, with 18% of streaming subscribers dropping their service each year. After its recent price increase, Netflix actually saw its U.S. subscriber base decline slightly in the most recent quarter. As I wrote in my article “Reality Is Closing in on Netflix”, the company’s price increases are not the result of pricing power, but instead a reaction to its rising content costs.
Competition Ramping Up
To the extent that Netflix has been able to sustain price increases in the past, it was due to the company’s first-mover advantage. Now, Netflix faces competition from Amazon Prime Video, HBO Now, and Hulu, and the competition is only going to get more intense. Disney, NBCUniversal (CMCSA), and Time Warner (T) are all launching their own streaming services in the next two years.
Disney’s streaming efforts, in particular, represent a significant threat to Netflix. Disney CEO Bob Iger announced on the company’s recent earnings call that it will offer a bundle of Disney+, ESPN+, and ad-supported Hulu for $12.99/month, the same price as Netflix in the U.S. As I wrote in “Disney’s Avengers Spell Endgame for Netflix”, Disney’s wildly popular tentpole franchises give it a significant edge in the streaming wars, and its ability to bundle that content with live sports and popular 3rd party shows is a major competitive advantage.
Netflix Is More Like A Traditional TV Network Now
The combination of all the above points – increased competition, lack of pricing power, and loss of licensed content – leads to a simple conclusion. Netflix is no longer a revolutionary tech platform, it’s just another TV network. I’ve been making this argument since my 2016 article, “The Spell Is Broken: Netflix Is More Like A Traditional TV Network”.
However, Netflix’s valuation does not resemble a TV network. The company has an enterprise value of $150 billion, about 5x the value of the largest standalone TV network we cover, CBS (CBS). Some people might scoff at the comparison of these two companies, but they earned about the same amount of revenue last year ($15 billion), and CBS generated $1.7 billion in free cash flow to Netflix’s -$4.5 billion.
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