Netflix, Inc. (NASDAQ:NFLX) has had a bumpy month after its share price broke above $320 and then swiftly dipped down to $280 within a matter of weeks. But the market overall has been shaky so far this year, especially for tech stocks which have been weighed down by bad press and worries about unreasonable valuations. NFLX stock has since made its way back above $300 per share, but that doesn’t mean you’ve totally missed the boat — Netflix is a solid long-term pick with a lot of growth potential as the streaming space matures.
Concerns for NFLX Stock
That’s not to say that Netflix stock is without risk. The company’s overall business model is risky in itself.
When NFLX first started streaming content, it was essentially renting it and simply distributing to its subscribers. Over the past five years, that strategy has shifted and the company has become a content producer — and it’s on its way to becoming one of the largest in the world.
That kind of change is expensive, and Netflix has had to borrow quite a bit of money to get there. NFLX’s big bet on original content has caused the company to report negative cash flow and accrue higher and higher levels of debt every year. And that has, understandably, become a major concern for investors.
Netflix’s Impressive Subscriber Growth
Netflix stock has been able to continue rising despite the firm’s mounting debt pile because the business is growing at an outstanding rate. During the fourth quarter, NFLX increased it’s domestic subscribers by 10.7% and international subscribers were up 41.6%.
In the upcoming quarter, management is expecting similarly impressive figures as well as a near 40% revenue increase.
That’s why Netflix can get away with spending so much. Management is using this period of incredible growth in order to build up an unstoppable library of content that will pay off for years to come. Since Netflix will own the content, it will reap the financial rewards for years to come. This is why the bulls argue that the excessive spending is a necessary evil if the company wants to set itself up for long-term success.
As my colleague Vince Martin pointed out, NFLX stock is balancing on a narrow tightrope with this strategy. There’s a chance that market uncertainty could leave the company struggling to find creditors in a time of need. There’s also a possibility that investors might look start to doubt the value of Netflix content, which would bring the stock crashing down.
Martin points to competitors like Walt Disney Co (NYSE:DIS) and CBS Corporation (NYSE:CBS) who have massive content libraries of hit shows and movies, but investors aren’t willing to give them the same credit. I’d argue that DIS stock is undervalued at the moment, because I think the company’s entry into the streaming space is going to be a big one with or without FOX. At the moment, Disney has a huge library with no one to watch it, and that’s why the stock has been lagging all these years.
But it’s also important to consider that neither Disney nor CBS have the same compelling streaming growth story that NFLX has.
Over the next few years, Netflix will certainly have to temper its spending because user growth can’t continue the way it is forever. However, as the streaming space continues to grow and mature, I believe NFLX will continue to see gains.
Sure, the space is getting more crowded as the competition heats up — especially with the entrance of DIS. However, I think new streaming options could actually be good for NFLX. Disney is sure to appeal to a wide range of people with it’s massive library of popular franchises, but there’s enough room for more than one great streaming service.
Paying for Netflix, Disney and even a few other streaming subscriptions will still come in far below what people would be paying for cable.
For that reason, I think adding strong competitors to the space will actually convince more people to cut the cord and pick up a variety of streaming subscriptions in place of traditional cable — I don’t think it will cause people to choose between NFLX and DIS.
The Bottom Line
NFLX stock certainly doesn’t come without risk and it’s worth considering the worst-case scenario that Vince Martin pointed out.
However, the company’s long-term growth trajectory looks promising and although its debt obligations are a concern, I think management is making a smart bet on the future with original content.
As of this writing, Laura Hoy was long NFLX.