Calling a spade a spade, Netflix, Inc. (NASDAQ:NFLX) scored a fairly important victory last week by convincing Comcast Corporation (NASDAQ:CMCSA) to allow the streaming video service to play through its X1 set-top boxes.
The deal won’t immediately drive a huge boost in the value of NFXL stock, as only 8 million of Comcast’s subscribers currently use that particular hardware. Some of them may already be subscribers too, and others may have no interest in Netflix.
Nevertheless, now that Comcast has gotten on board, CEO Reed Hastings can approach other cable television providers and suggest they should follow Comcast’s lead.
The question is, will this new model work to rekindle Netflix’s slowing growth? Jefferies analyst John Janedis doesn’t think so, and he’s not alone.
Problems Here
On Tuesday afternoon, Jefferies downgraded NFLX stock from a “hold” to an “underperform,” simultaneously lowering its price target on Netflix shares from $120 to $80.
While Janedis still believes Netflix is a fine company with a promising future, he also see domestic (U.S.) growth slowing down now that viable competition is surfacing and the on-demand video market is saturated. He explained:
“[regarding a projection of between 60 million and 90 million subscribers] The low end of this range implies a BB home penetration rate of 52% (from 44% in ’15) — well ahead of all peers. Given the platform’s existing penetration rate, and the threat of building competition, we expect growth to moderate going forward.”
For perspective, Netflix ended Q1 with 81.5 million subscribers globally, 47 million of which were U.S. viewers. Subscriber growth has been surprisingly linear as well, with U.S. memberships being the foundation for that steady progress.
Janedis isn’t wrong to expect a trajectory change sooner than later though. There are only so many households in the United States (about 124 million) and only so many of them have the broadband internet connection to make the Netflix service viable (about 2/3 of homes).
And interestingly, we’re now seeing the number of wired broadband connections fall as users migrate to a smartphone-only connection to the world. This suggests the size of the potential market itself has reached a plateau. Underscoring this saturation premise is the fact that growth in the number of smartphone users in the U.S. is decelerating … fast.
Beyond 2020, that growth will be near immeasurable.
At the same time, the rise of alternatives to Netflix has become undeniable. Hulu — a joint venture of Walt Disney Co (NYSE:DIS), NBCUniversal and FOX — as well as the on-demand video library Amazon.com, Inc. (NASDAQ:AMZN) offers Amazon Prime members are giving consumers an either/or choice. Hulu already boasts 12 million subscribers. Amazon Prime’s numbers are a little fuzzier, but experts say there are north of 50 million members.
Some on-demand video subscribers certainly use more than one service. But, some don’t, and the would-be customers who’ve yet to sign up for any streaming service (assuming they even have a way of accessing it) could be tough to convert, and it could take a while if it happens at all.
Problems There
While the core of Janedis’ concern regarding the future of NFLX stock stems the aforementioned domestic concerns, the downgrade comes just one day after Needham analyst Laura Martin also downgraded Netflix stock from a “buy” to a “hold” on international concerns.
Martin wrote, in light of the potential Brexit fallout:
“We believe that a NFLX subscription is a luxury item, paid for with excess cash after rent/mortgage, food, etc. EU and UK GDP’s slowing over the next 2 years implies slower job growth and lower consumer FCF to pay for NFLX subscriptions than our estimates 3 wks ago.”
The comment augments something else Janedis mentioned on Wednesday about Hasting’s international ambitions:
“Key challenges include a limited amount of local content, language barriers, an expensive price point in certain markets, and underdeveloped payment processing/broadband infrastructure.”
Bottom Line for NFLX Stock
Perhaps the most alarming aspect of the joint one-two punch combination from Needham and then Jefferies is the rational, verifiable logic behind them. There does come a point where the interested U.S. market is fully tapped, and unless subscribers start opting for multiple subscriptions, we’re nearly there. Meanwhile, the market size itself is effectively stagnating.
The overseas market isn’t nearly as saturated, but if the ripple effect of the Brexit is indeed going to create a global economic headwind — as most investors have said they expected it to, in light of the post-Brexit-vote tumble — then the ensuing economic malaise does indeed put a Netflix subscription low in the priority list of things to purchase.
Throw in the fact that the company continues to rack up debt at a faster pace than it grows revenue, and is burning cash like there’s no tomorrow, and it’s not too difficult to agree with Janedis and Martin … NFLX stock is becoming increasingly tough to own.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
