Netflix (NFLX) is America’s leading video streaming platform and one of the strongest tech brands on the market today. Having successfully managed the transition from the legacy DVD rental business to streaming, the company has become the entrenched leader in the digital content streaming space.
NFLX stock has been one of the hottest in the market recently. Shares more than doubled in 2015, and are up more than 10x from the 2012 trough. Is there any upside left from these levels, or has this trade played itself out?
Stock Pros
Netflix Has A Dominant Position: According to internet research firm Sandvine, Netflix now accounts for more than 36% of downstream internet activity. For comparison, Youtube is only 16% of traffic, iTunes and Bittorrent weigh in at 3%, and you find Facebook (FB) and Hulu even farther back in the rankings.
Netflix is the dominant player in streaming video, and while there is credible competition in the space, NFLX has a huge first mover edge. Additionally, combined with past data from Sandvine, you can see that Netflix is in fact expanding its lead. With Netflix already having more than double Youtube’s internet bandwidth travel and it continuing to grow, the company — and NFLX stock — is a force to be reckoned with.
Original Programming Is Building The Brand: NFLX has been on a huge hit streak with its Netflix original programs. In 2015, the company garnered an impressive 34 Emmy nominations for its portfolio of original productions. The company got these nominations across ten different programs, demonstrating that the company’s production success has not been a fluke.
The 34 nominations in 2015 were up from 31 in 2014 and 14 in 2013 showing a solid trend in the critical acclaim the company is receiving. These prize-winning shows are an essential part of building Netflix’s brand and controlling costs. Streaming services such music streamer Spotify that are 100% reliant on third parties to license content are always in danger of seeing their business harmed every time a contract renegotiation comes up. By building strong material in-house, NFLX is in a slightly less vulnerable position as far as content goes, and retains more leverage at the negotiating table with other media distributors and creators.
NFLX Is Growing Internationally: Netflix just announced plans to roll out its service pretty much everywhere in the world, except for China. While a lot of these are fairly fragmented or small markets, the effect of adding dozens of countries in aggregate could still be immense.
Netflix has grown its reputation, especially recently with its original programming. Long available only by proxy services or illegal pirating, NFLX’s original programming has probably built up a good deal of pent-up demand that will lead to strong subscriber uptake soon after launch. The US only makes up roughly 5% of the world’s population, even though emerging markets are much poorer than the US, the sheer size of the market opportunity could bear great fruit.
Stock Cons
NFLX Is Growing Internationally: Yes, this was in the pros, but it can also be viewed as a con. It’s one thing to a conquer a market you know well. It’s a totally different matter to enter dozens of foreign markets simultaneously. Particularly with media, there’s huge obstacles and barriers to entry.
To access even tiny countries like Iceland with fewer than 500,000 residents, NFLX still needs to do various things. Among them, license local content in the Icelandic language, license or create subtitles for American programming in that language, and hire customer support to interact with Icelandic speakers. Repeat that process in dozens of countries and dozens of languages, and you can see how costs to get up and running could be sizable. It isn’t really so simple as offering the service in a new country and seeing free incremental revenue roll straight on in.
Finally, NFLX already faces established competition in many countries. See this perspective from a Russian author for example. In that market, there are already two large streaming players that feature substantial venture capital backing, have relations with local content providers, and are operating at price points far below Netflix. It would require a lot to go right for Netflix to earn a major piece of the Russian and other similarly competitive markets in the near term.
NBC Data Shows Netflix Has Limited Impact: In a defense of the traditional TV model, Comcast‘s (CMCSA) NBC revealed data that NFLX probably didn’t want people to know about. NBC showed that viewership for Netflix’s much hyped series such as Jessica Jones and Narcos are getting only comparable viewership with average network fare.
After an initial burst of consumption, viewership falls off sharply for Netflix shows. Orange Is the New Black was already well under one million viewers in the time NBC measured audience despite originally starting very strong this past June.
NBC further noted that online viewing in general is not nearly as big a threat as people may think. Even among younger demographics, traditional TV viewership is still the norm. 18- to 24-year-olds watch 62 hours of traditional TV per month, compared to just 12 hours on YouTube.
Stock Is Crazy Expensive: The elephant in the room is the NFLX stock price, which trades at a triple digit PE ratio. That is fine in some cases, however in Netflix’s case, the valuation seems too steep. The company has been profitable every year since 2003, but has shown no ability to consistently grow earnings. The company regularly turns some sort of profit, but it is always minuscule and wholly incapable of supporting such a lofty share price.
Bulls can point to steady EBITDA growth, and they’d have a point. However, even on an EV/EBITDA basis, it’s at 125 now, which is absurdly expensive. A note of caution: Content companies often use quirky accounting relating to advertising to attract subscribers, and also with the building of content libraries. AOL looked far more profitable on paper than it was in reality during the 1996-2000 tech run-up since it was counting the CDs it was sending everyone as long-term investments rather than current marketing costs. Similar quality of earnings concerns could be made in this case.
Verdict
I wouldn’t buy NFLX stock at today’s prices. I wouldn’t buy it even at prices well below the current price. The stock is priced to perfection, and you would need a ton of things to go right for the company’s shares to continue rising. With the risks that international expansion bring, to say nothing of domestic competition, I see the stock as too expensive to be taking a chance on for anything other than short-term speculation.
At the time of this writing, Ian Bezek held no positions in any of the stocks mentioned.
