In 2019, Netflix (NASDAQ:NFLX) stock has attempted to breakout above $380 in more than one occasion. Each time, the stock has trended lower. In the most recent instance, NFLX stock made a high of $381 in the second week of July. Currently, the stock is lower by 31% from July levels at $263.
I am of the view that a $380 high for NFLX stock is unlikely to be breached anytime soon. On the contrary, the stock is likely to trade sideways lower. This coverage will discuss the factors for a neutral-to-bearish view on the stock.
Google Trends In-Sync With NFLX Stock
I would like to present an interesting chart on Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google Trends for the last five years for the term “Netflix subscription.”
As the chart shows, after peaking at 100 for the week July 21 to July 27, 2019, the interest has declined significantly to current levels of 60.
Numbers represent search interest relative to the highest point on the chart for the given region and time. A value of 100 is the peak popularity for the term. A value of 50 means that the term is half as popular.
The most interesting part of this search trend is as follows: Search popularity peaked out in July almost at the same time as the stock price peaking out. As search popularity has declined, the stock is at negative returns for 2019.
Of course, I am not suggesting that Google Trends will always act as an indicator or leading indicator. Nor am I suggesting that the growth story is over for NFLX. But I strongly believe that the company might be headed towards a relatively muted growth trajectory. NFLX stock is moving lower, discounting the slow growth factor.
Growth Rate Not the Only Concern for NFLX Stock
One of the concerns for NFLX stock is the subscriber growth and the potential deceleration in revenue growth. However, there are other areas of worry that will be discussed more by the markets in the coming quarters.
As an example, Netflix reported total long-term debt of $4.8 billion as of June 2019. For the period ended June 2019, the company’s debt had swelled to $12.6 billion. Leveraging is not necessarily bad, but it is a concern considering the following factors:
- The company’s operating cash flow was a negative of $1.8 billion for the year ended December 2017. OCF deteriorated to a negative of $2.7 billion for the year ended December 2018. For the first six months of 2019, the OCF is at a negative of $900 million.
- Even as NFLX remains the leader in streaming content, competition is increasing. HBO has a strong backing coming from parent company AT&T (NYSE:T). Others companies like Disney (NYSE:DIS), Apple (NASDAQ:AAPL) and Amazon (NASDAQ:AMZN) are all investing billions of dollars in content acquisition and original content creation. All these companies have significantly better financial muscles as compared to NFLX. In all probability, they will not reach even close to the subscriber base of Netflix in the coming years. However, competition will certainly impact subscriber base growth and revenue growth for NFLX. In turn, NFLX stock will adjust valuations on the downside.
- Since Netflix has to compete with companies that have robust financial resources, the only strategy is to keep investing in content. Therefore, with cash burn, the company will continue to incur high content cost. It implies further leveraging or equity dilution in the coming years.
I am not painting a doomsday scenario for NFLX stock. However, it would be very optimistic to expect the same subscriber growth or revenue growth trajectory.
Next 24 Months Critical for NFLX
Louis Brennan, a professor at the Trinity Business School, penned a very insightful article (Harvard Business Review) on how NFLX expanded to 190 countries in seven years.
While the article focuses on the company’s strategy for expansion and the understanding of local taste and preference, the following is an important observation:
With the increasing prevalence of winner-take-all markets, companies operating in such markets will need to pursue an internationalization strategy similar to Netflix’s.
The key point being that competition does not necessarily imply that NFLX will lose in the long run. If Netflix can maintain strong content and focus on local preferences, it can potentially overcome the competition headwind.
I believe the next 12-24 months will decide the “winner-take-all” in the business of content streaming. If this does hold true, Netflix can potentially transform into a cash machine.
However, investors will have to wait for the impact of the current wave of new entrants. For now, the concerns will dominate headlines and the stock is likely to remain sideways to lower.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
