It is often said that a good company might not be a good investment. This holds true for Netflix (NASDAQ:NFLX).
In 2019, Netflix stock touched a high of $385. However, with the second quarter results not in sync with analyst estimates, the stock has declined by 24% to current levels of $291.
I am of the opinion that the NFLX stock will continue to trend lower in the coming quarters. This article will discuss the factors that make me bearish on the stock. In particular, my focus will be on increasing industry competition and its impact on a sustained cash burn.
Cash Burn Concerns
Netflix witnessed relatively slow subscriber growth in the second quarter. I believe that this challenge is likely to sustain in the coming quarters. The key reason for this is a flurry of new entrances in the industry.
Be it Netflix or any other streaming service, there is no doubt that content is king. For the six months ended June 2019, Netflix spent $6.3 billion in adding streaming content assets. For the same period, the company had to issue $2.2 billion in debt to cover expenditure related to content creation or acquisition.
While NFLX still has $5 billion in cash, negative operating cash flows will imply sustained cash burn. As a matter of fact, Netflix expects improvement in cash flows, but there is still no definite guidance on when the operating cash flow or free cash flow will turn positive.
The concern for Netflix is that as competition intensifies, the investment in original content or acquired content will increase. If revenue growth is not in sync with investment growth, cash burn can accelerate.
NFLX’s plans to cover content spending through debt issue and equity dilution might not be a concern. However, stress on the balance sheet needs to be monitored as the company already has $12 billion in debt.
Competitors with Financial Muscles
HBO Max will be launching in early 2020 and has been on a content shopping spree. HBO Max outbid Netflix for the entire “Friends” series. The positive for HBO Max is that AT&T (NYSE:T) has billions of dollars in cash flow for content shopping. If the subscription war heats up, AT&T will have headroom to lower subscription cost and gain market share. NFLX does not have this flexibility.
Similarly, Apple (NASDAQ:AAPL) is likely to launch streaming services in November and the company has over $200 billion in liquidity. Apple is considering an investment of $6 billion for content acquisition. Considering the company’s cash buffer, it would not be surprising if Apple pursues inorganic growth as industry competition intensifies.
It might be too early to speculate if Apple will be interested in acquiring Netflix. However, I do see that as a possibility if Netflix continues to burn cash and the NFLX trends lower.
To add to the competition, Disney (NYSE:DIS) will be launching a bundled package that will include Disney’s own content, ESPN and Hulu for $12.99 per month.
Amazon (NASADQ:AMZN) will reportedly be spending $7 billion on video and music content in 2019. The company’s cash balance is also close to $50 billion.
The point I am making here is that big players are willing to spend billions of dollars to acquire content. Netflix might not be able to compete with the likes of Amazon, Apple and Disney when it comes to spending on content acquisition. At the same time, Netflix might find it difficult to lower subscription prices if big competitors offer attractive packages to attract subscribers.
The Bottom Line on NFLX Stock
Strong competition poses a major challenge for Netflix amidst a global economic slowdown. If the company has to pursue acquisition of content more aggressively, cash burn can accelerate.
There will be more clarity on these concerns in the next three or four quarters as competitors launch their streaming services. I believe that Netflix stock will remain sideways or trend lower during this period as the markets wait to judge the impact of competition on subscriber growth.
It is entirely likely that the game is not over for Netflix. The company is expanding on a global subscriber base and that can sustain at a slower pace. However, the valuations also need to adjust on the downside if slower subscriber growth holds true.
Therefore, investors need to wait for that valuation adjustment or a confirmation of the fact that Netflix can grow at a robust pace amidst strong competition.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
