Netflix, Inc. (NASDAQ:NFLX) got hammered on Monday. NFLX stock fell as much as 5% on the day, blowing up what had been a strong uptrend for the stock.
Netflix had a strong summer. But the first sign of trouble appeared for the stock on August 8, when Walt Disney Co (NYSE:DIS) announced it’d be pulling much of its content off of Netflix’s platform. NFLX stock fell from its $190 peak to as low as $165. However, shares rallied back, touching the $190 level again last week. Does the latest decline represent another solid dip-buying opportunity? Or should investors worry that the stock’s momentum has now flipped to the downside?
NFLX Stock Cons
Rising Competition: Last month, Disney announced they’ll be pulling much of their content off Netflix’s platform. It’s unclear what all will stay and go, but the impact will be sizable. Disney has ambitions of starting its own streaming service, and that’s certainly not good news for NFLX stock going forward.
Investors largely shrugged that off, as Netflix stock started to recover. However, on Monday, another competitor took aim at Netflix. Twenty-First Century Fox Inc (NASDAQ:FOXA) announced that its FX+ service is growing. The streaming service will be offered through Cox Communications, adding to its pre-existing distribution through the Comcast Corporation (NASDAQ:CMCSA). FX+ offers subscribers access to 16 current and former FX series for just $5.99/month. It’s becoming increasingly clear that, at least in the short-term, there will be ever more streaming service competitors.
Tech Stocks Under Fire: Tech bellwether Apple Inc. (NASDAQ:AAPL) has dropped almost 10% since its recent high. That’s bad news for the S&P 500 as a whole, since Apple is the market’s largest stock. It’s particularly bad news for the tech sector, since Apple is by far the biggest holding in the key tech industry fund, the PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ), constituting 12% of the ETF. Weakness there tends to ripple over to the other big tech stocks, such as Netflix.
There are problems cropping across the FANG stocks, many of them are sliding. Facebook Inc (NASDAQ:FB) in particular got hit for a nearly 5% decline on Monday. Mark Zuckerberg is unloading a large chunk of his stock, perhaps out of concern as the political problems I recently documented continue to tarnish that company’s image. Add it all up, and bears smell blood. The tech stocks have been ripping all year. The Nasdaq is still up 20% year-to-date despite the recent losses. A steeper correction wouldn’t be unusual, and it could rock NFLX stock in the short-term.
Expensive Stock: NFLX stock is one of the most expensive growth plays you’ll ever see. Shares are trading at a jaw-dropping 213x trailing earnings. If next year’s growth comes in as planned, NFLX stock would still sell at 108x earnings. Other ratios don’t look much better. Netflix is selling at 8x sales, and an astounding 25x book value. Even compared to most rapid growth stocks, it is rare to see these sorts of numbers.
The huge valuation would be justifiable if Netflix were still on a clear path to world domination. However, it’s not. The content owners such as Disney and Fox are rapidly taking measures that attack Netflix’s core customer proposition. Going forward, Netflix either has to spend (much) more on content licenses, or make more of its in-house content. Neither of these will be helpful to Netflix’s already ailing earnings picture.
NFLX Stock Pros
Netflix Has The Platform And Brand: It’s unlikely that all these new streaming competitors will survive. Ultimately, consumers want an easy all-access streaming solution. Spotify may not be the best streaming music service, but it is cheap, has a reasonably good GUI, and offers a broad enough library. Video is just begging for the same solution, and Netflix has, by far, the best platform and consumer brand.
Spotify effectively saved the music industry. With cable-cutting only accelerating, the value of video content is going down rapidly. Disney, Fox, etc. are making a huge error in trying to build their own platforms, rather than partner with Netflix. Most consumers won’t subscribe to five or ten streaming services to get all the content they want. They’ll just pirate it instead. The alternative, a reasonably-priced service like Netflix, is better for everyone in the long run. Hopefully, the content creators will figure it out in time.
Good Original Content: Netflix has reacted decisively to this situation. Realizing that their content partners were starting to freeze them out, Netflix aggressively rolled out its own original content.
Programs such as House of Cards, Orange Is The New Black, and Narcos have done a ton to drive new subscribers and retain existing ones eager to see the next season. That’s helped maintain Netflix’s subscriber base even as it continues to bleed more and more content from other partners.
Revenue Growth Accelerating: Netflix’s last quarterly results came in sparkling. The company’s strong content line-up led to better than expected domestic subs and increasing success internationally. Overseas, Netflix is increasingly grabbing the first-mover edge it achieved years ago in the United States. Price increases outside of the US should pave the way for growth in future quarters.
In fact, the last year has been a strong one for Netflix. The company has grown revenues at a 32% rate. That’s even faster than usual for the company. Over the past five and ten years, Netflix has grown revenues at 20% and 26%/year, respectively.
Unfortunately for the NFLX stock price today, that revenue growth isn’t nearly enough to outweigh the cons. Netflix’s investors are hoping revenue growth will overcome accelerating costs.
But the fundamental business model just isn’t working at the moment. And with more and more content providers pulling out and launching their own competition, things will only get worse. In the long run, Netflix has the best brand, and the content makers may have to come back after their own streaming platforms crash and burn. But we aren’t there yet. I see a rough year or two ahead of NFLX stock.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.