The ongoing bull-bear debate over Netflix, Inc. (NASDAQ:NFLX) stock tends to focus on the following collision of opinion: Netflix has so many subscribers and so much original content that it will continue to lead the world in streaming … but Netflix makes very little money despite all of those factors.
I am of the opinion that NFLX stock is insanely overvalued, and that it will one day disappear, but a few things will happen between now and then. Nonetheless, a recent development over at Twenty-First Century Fox (NASDAQ:FOX, NASDAQ:FOXA) demonstrates that NFLX is no longer anything special. Fox is starting to live-stream its programming. It has its own platform, as do many other networks like HBO.
NFLX stock soared for many reasons, but one of them was that it was the only streaming platform for a long time. That’s not the case anymore. While it still has a great selection of licensed content, Amazon, Inc. (NASDAQ:AMZN) continues to increase its market share.
Netflix: Life Is Expensive No Matter What
You’ll notice that what Netflix did was pivot very hard to expanding original programming. This had to occur because it was starting to get cash-constrained. Why do you really think the BBC’s wildly popular Doctor Who moved from Netflix to Amazon? Because the BBC got more money from Amazon.
At the end of 2013, NFLX stock was backed by just $605 million in cash, and the company has since had to raise more money. Netflix management realized that they could no longer own the licensed content market because everyone else was developing their own streaming technology, and could charge people directly for that content.
So NFLX decided it would have to pick and choose what content to license, and use the rest of its money to distinguish itself in a new way — produce original programming. Now, Netflix has done that remarkably well. Many of its shows are terrific. People are willing to pay for that original content, much in the way HBO built its customer base.
Except now, Netflix is in a new pickle.
Whereas Netflix couldn’t afford (and it made less and less sense) to license content, now it needs to raise cash to produce original programming. That’s a very expensive proposition. Trust me, I was in the television business for 12 years.
The way most shows get produced is through “deficit financing.” The studio acts as both a bank and production house. It puts up the money to produce the show, then licenses the show to its sister company (the network), which then makes money by selling ads for the show. That’s usually not enough to put the show into profit, so it also gets released on DVD and licensed to Netflix and Amazon and airlines, and so on.
Most shows lose money.
For pay-cable and Netflix and Amazon, it’s all about subscriptions or a la carte sales. Those numbers never get released, which I think is unethical for shareholders, so we don’t know just how much revenue or expenses are generated.
Clearly, though, some companies are making some kind of money. Starz (NASDAQ:STRZA) would not be continually producing programming if it wasn’t making money.
NFLX Just Can’t Keep Up
Netflix is basically trying to play the same game, but it has limited resources. Obviously, it will have to raise prices as time goes on, like it just did. The more programming it has, the more Netflix hopes people will pay for a subscription to watch it all, so it becomes a kind of subscription VOD network.
It’s going to take a lot of money to do this, and that money will be expensive. It will also take a lot of money in marketing to generate and maintain enough subscription revenue to keep this model afloat.
If the content has no interest for international audiences, Netflix stock is in trouble. Netflix already has two problems because, while some U.S. programming interests some nationalities, most of it does not. People in other countries want to see their own faces and stories. In addition, the “binge watching” culture does not exist overseas as it does here.
All the while, NFLX has terrible financials. It barely generates a useful profit, and even mentioning the term “cash flow” is laughable.
Eventually, Netflix stock will fall dramatically. When it’s market cap hits the right place, another content provider with deeper pockets will buy it for its content library and brand name.
That’s a long way off, but between now and then, the path of least resistance for NFLX stock is down.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com. As of this writing, he did not hold a position in any of the aforementioned securities.
