Netflix lowered their subscriber numbers for the year last night, leading to a big 14% drop in the stock price today (so far). Fellow InvestorGeek Chris texted me asking if I’d be buying Netflix in the 50s.
I personally won’t be buying any $NFLX stock today, but only because I already own a lot of Netflix stock int he $60s. I have too much tied up in $NFLX already to add to my position. Though I may buy in more later this year, early next, as I fund my account and if $NFLX drops lower.
I believe in Netflix long term, and am building up a position with the intention to hold at least through the current international expansion and the implementation of their original content (Arrested Development, House of Cards).
Buying now is not a no-brainer. But could be an opportunity if you think long term.
Think Long Term with Netflix
Any investor in Netflix now has to be ready to hold for at least a couple of years. The current market is very focused on earnings right now (excluding Amazon investors for some reason), and Netflix won’t have earnings for a while as they reinvest them into international expansion and content expansion.
The play here is that once Netflix stops spending money on expansion, they’ll be able to keep a large portion of that $7.99 per subscriber per month they are getting. Why not?
That said, $NFLX stock has tended to swing fairly predictably after these big moves. So I think a quick trade once this current action bottoms out could result in a nice 10% gain. But the current trend is down. Don’t trade against that unless you are tuned in.
Chris asks me if I think the “bleeding” of subscribers has stabilized. The answer is yes. All of the subscribers who were going to leave because of the price increase seem to have left already. Netflix is losing DVD subscribers, but that is expected, and new streaming subscribers are offsetting those losses.
Some subscribers may be leaving because of the lack of content. Or to switch to a competing service. But these don’t seem like huge structural issues to me… really just part of normal turn over for a service with competition. Netflix is the best video streaming service and will be for some time to come.
Which brings me to the two main things to worry about with Netflix: (1) competition, and (2) cost of content.
Worry #1: Competition
I’m not as worried as many about Amazon and other competitors in the space. Netflix did well against Blockbuster back in the day. Many underestimate the cost of building the infrastructure to become the largest source of traffic on the internet. Really only Amazon has the chops to replicate this. But then Amazon has some other problems.
Amazon is way behind in terms of devices for their service. By the time they catch up, Netflix will be on your car and in your Google Glasses. Amazon is also behind in terms of recommendation technology. This, coupled with the fact that Netflix knows my past viewing history, means that Netflix is going to be a better browsing experience for me.
And last, but not least, Amazon will always have a schizophrenic business model for video since they want to stream free movies alongside movies you have to pay for. There is a place for this, but it means that Netflix will always stand out as a nice easy way to find something to watch. There is no incentive for Amazon to switch to all free streaming when they make billions more already from selling actual videos.
Worry #2: Content Costs
On the content cost side of things, some are worried about the “off-balance-sheet debt” that Netflix has. Some information here and here. In more laymen terms, Netflix has contracts worth billions of dollars with content providers that go out over several years. These costs don’t make it onto the balance sheet as debt (or payments owed) because the accounting only shows what is due the current year. Some believe that Netflix has been manipulating these contracts so the payments are due later, and expect a large increase in these costs soon that Netflix won’t be able to cover with revenue.
It’s possible some shenanigans are going on here. Personally, I have some trust in Netflix management and see this as a reasonable way to do accounting for contracts that go into the future. On the extreme side, if Netflix signed a 30 year contract to pay $200m to a content provider, you wouldn’t expect them to consider that $6B worth of costs right now. It makes sense to spread that out over the years the content is being streamed.
Outside of the off-balance-sheet debt, some worry that content providers will charge more for content or even collude to choose a winner in the space (maybe Hulu, which is owned by NBC, Fox, and Disney). It’s possible, but I already see signs that Netflix has gotten large enough to enforce some leverage of its own in these negotiations. So while Netflix lost out on Starz’s content. Starz lost out on as much as $200m per year. Other Networks would have similar pay checks to lose. As Netflix grows, they’ll become a larger source of revenue for the content providers.
I don’t want to make it sound like the concerns of investors right now are minimal. They aren’t. Netflix faces some big challenges ahead of it. However, if you believe in the company’s ability to navigate these challenges, there is a huge payoff for what may become a huge business.
For a sense of the potential here, Netflix currently has 25m subscribers. They will make about $3b/year revenue off these subscribers. The top 20 countries together have over 400m broadband users. As broadband penetration grows and Netflix’s international reach grows, can they grow to 50m subscribers? 100m?
At current prices, you can get $NFLX stock at less than 1x revenue. For a company that is growing, this is a steal. There are real concerns with competition and content costs, but many under estimate the technical and competitive advantage Netflix has as the early leader in streaming, which is currently the largest streaming service in the world.
Again, buying in at current prices is NOT a no-brainer. For those who think Netflix will be a big player in streaming 5 years from now, yeah. Buy on the dips.