Netflix, Inc. (NASDAQ:NFLX) has had a torrid start to 2018. Netflix stock has been the best performer in the S&P 500 so far this year, a full 21 points better than CSRA Inc (NYSE:CSRA), which is being taken over by General Dynamics Corporation (NYSE:GD).
Admittedly, I’ve been surprised by the 57% YTD increase in Netflix stock. I argued in December that Netflix stock was likely to stumble in 2018, which quite clearly hasn’t been the case. But what’s interesting about the big run in NFLX is that I’m not sure the news in 2018 has been all that impressive.
A blowout fourth quarter report with subscriber growth 2 million higher than expected drove a 10% post-earnings jump. But NFLX has gained 27% just since intraday lows on Feb. 9, amid widespread broad market weakness.
And from a long-term perspective, there’s one key concern raised by Netflix’s current valuation. I’ve long worried that Netflix could struggle as it shifted from content distributor to content creator.
So far this year, that shift doesn’t necessarily seem to be going all that well. Netflix’s new content isn’t exactly garnering rave reviews. Meanwhile, its spend is exploding.
Right now, investors seem confident Netflix’s subscriber growth, data, scale, and existing leadership will be enough. With Netflix stock over $300, they, and Netflix management, better be right.
Netflix Stock Shrugs off Another Flop
In December, Netflix released the Will Smith vehicle Bright – which I thought at the time encapsulated the bull/bear argument over NFLX. Bright got generally poor reviews. But viewership was strong, to that point that Netflix ordered a sequel to the $90 million project.
Netflix was able to use its existing base and its treasure trove of data to advertise the film to subscribers in a way that Hollywood studios simply can’t. Perhaps as a result, the audience score was much better.
But Bright was followed by last month’s release of Mute – another critical flop. Rotten Tomatoes gave Mute a 12% critic score, and one critic called it a “Netflix disaster.” This time, however, audiences seemed reasonably dismayed as well, with just a 52% audience score.
The steady stream of relatively substandard movies, which also includes The Cloverfield Paradox and When We First Met, creates a potential problem. Netflix announced last year it would release roughly 80 movies in 2018. The six largest studios combined put out 94 last year. And a Vulture essay last month highlighted the issue here:
To release 80 movies in a single year, Netflix must roll the dice on quite a few of these screenplays that haven’t been produced and films that haven’t sold…It isn’t enough to assume that there are idiosyncratic gems lying around, misunderstood and waiting for the warm embrace – read: lower financial obligations – of a nontheatrical release; there may be a few of these, but there aren’t 80.
NFLX Needs to Win in Content
If Netflix is going to make 80 movies a year, it needs to monetize a good number of movies that studios like Walt Disney Co (NYSE:DIS), Time Warner Inc (NYSE:TWX) unit Warner Bros., and Sony Corp (ADR) (NYSE:SNE) cannot produce at a profit. And it’s possible the company can do so.
Those companies don’t have 124 million subscribers at the wait, after all. They don’t have the international base, or the growth potential: Netflix CEO Reed Hastings has said that Netflix could add another 100 million subscribers in India alone.
A film that isn’t worth, say, $12 a ticket to a Disney or Sony customer might be worth $1 or $2 to a Netflix consumer. That might be good enough.
The Bottom Line on Netflix stock
But given the money Netflix is spending, it will have to be. And it’s not just in movies. The company spent a reported $250-$300 million to poach producer Ryan Murphy from Twenty-First Century Fox Inc (NASDAQ:FOX,NASDAQ:FOXA). That’s on top of at least $100 million for ABC’s Shonda Rhimes. Netflix’s cash flow is negative, as many NFLX bears point out, because of the upfront content spend required.
That’s OK – if that content pays off. Increasingly, that looks like the key ‘if’ when it comes to Netflix stock. For that content to pay off, Netflix is going to have be better at content than anyone else. Better than Disney; better than Fox; better than Amazon.com, Inc. (NASDAQ:AMZN).
Investors at the moment believe that’s indeed the case. But at $300+ per share, there’s no room for error.
As of this writing, Vince Martin has no positions in any securities mentioned.
