Netflix (NASDAQ: NFLX) had one of the worst days in company history, when it reported the first decline in subscribers in more than a decade. The company’s AH market capitalization dropped to $120 billion, representing a more than 60% drop in the company’s market capitalization in just 6 months. However, despite this weakness, we believe there is more to come.
We’ve always been bearish on Netflix’s valuation relative to its peers and these earnings are a great example of that as the growth story changes.
With weak earnings in January as well, the company’s stock continued to decline towards its after-hours price of just under $260/share. The bearish thesis remains the same, and while the company indeed continues to lose money, what investors are seeing here is a reassessment of the company’s outlook.
Specifically, as competition increases and Netflix transitions from a unique technology company building its own industry to another company in a crowded market, the company is no longer a growth stock. Instead, it becomes more of a value stock, which means its P/E ratio will contract and it should be priced as such on its earnings.
Unfortunately, due to management decisions, we expect things to get worse.
Netflix Price Increase and Account Sharing
In our opinion, Netflix is at an impasse. The company sees its finances deteriorate, the number of subscribers dwindle, and it goes down the classic path of a struggling business.
Specifically, the company has constantly increased its costs. In this context, Netflix announced a possible crackdown of the 100 million households sharing accounts. These are households that purchase multi-screen viewing, but potentially share the account with their long-lost friend, ex or relative. However, we believe that this path has 3 risks.
- It’s hard to distinguish when you’re sharing the account with a random friend versus your kid who’s on vacation or at college. Errors here risk worsening the user experience.
- Users pay for the number of screens that can be displayed simultaneously. Restricting these screens to screens in one location not only risks downgrading user accounts, but also, again, worsens the user experience.
- Even if the experience is enough, such a move would cause Netflix users to re-evaluate their subscription. With plenty of alternatives, they might see it as a good time to cancel.
More so, the company can only annoy users one way at a time, and that’s where we struggle with management decisions. The company has been raising prices for streaming services faster than any competitor, which could once again cause users to reevaluate their decisions. The company hinted at users lost in revenue from the price increase, though it said that was in line with expectations.
Netflix’s growing subscription means its market share continues to erode, hurting its value proposition.
Specifically, most of Netflix’s market share decline went to HBO Max, as seen in the chart above. With HBO Max combined with Discovery+, we see the service as now a major player in the streaming universe, comparable to Disney+ and Hulu as independent properties. New content and a strong legacy library could mean continued growth.
HBO Max continued to show record growth.
There is another aspect of growing competition that is worth highlighting. Netflix’s competitors have much stronger financial positions for content. They have decades of connections, resources, costumes and stages. They have connections to existing talent, which keeps costs down. They can operate at cost in a way Netflix can’t, which means they’re more profitable with every market share.
No Content Library
Here we get, in addition to the price increases and lack of sharing, the crux of Netflix’s problem, and why we think the carnage will continue (despite the optimistic nature of management).
This thread on Reddit Investing on the company’s income is clear.
Maybe they should try to make better content. Or stop canceling every show before it can gain popularity.
or stop giving “AAA” movie stars ridiculously expensive sums of money for movies that aren’t good.
They kept raising the prices on me. I would have continued to subscribe even if I had hardly looked at anything on it, but all those higher price reviews backfired as they eventually caught my eye and I threw them away.
$19.99/month to watch Ozarks and Stranger Things is way too much. All new content is rushed trash
Not only do they keep raising prices, but they keep losing catalogs. How did Halt and Catch Fire disappear? ?
Even if you find the perfect show that perfectly matches your tastes, good luck with a second season because it probably doesn’t match the tastes of 80-90% of subscribers.
For starters, the company is in a worse position than its competitors. Apple (NASDAQ:AAPL) has similar struggles and has approached this by having the lowest priced service by focusing on a few high quality shows. Netflix has done the opposite, splashing out $10 billion worth of substantial, normally canceled content as it tries to find this “successful” show.
This “successful” show might not hold users back because it’s so rare, but users will remember how hard it was to find this show. Without a legacy content library, there’s nothing by default. Until the company redefines its approach to content, emphasizing modest quality at low cost, we expect the company to continue to underperform.
This makes the company a bad investment in our opinion.
Our point of view
In our view, investors considering investing in Netflix as a value stock should still wait. We expect the company’s quarters to continue to be difficult and the company continues to prepare for an increase in subscriber loss. The company finds itself in a more difficult position than most of its competitors and it has no clear path to resolve this problem and start generating solid profits.
This makes the company a bad investment in our opinion.
The biggest risk to our thesis at this point is potential consolidation. We talked about how Warner Bros. Discovery (NASDAQ: WBD) is a unique acquisition opportunity, and as Netflix’s price drops, the same could happen. Alternatively, the company could reduce content spend and focus on FCF. Or could enable higher returns for shareholders relative to the difficulties we anticipate.
Netflix deserves all the credit for defining a new and exciting industry. Unfortunately for the company, it started its content creation business too late, and it still lacks the expertise to effectively create quality content at low cost. More so, the company doesn’t have a decades-old library of content to fall back on.
Going forward, we expect the company’s heavy capital expenditures to continue to keep FCF low. The company still has a market capitalization over $100 billion, which means that if the market revalues it as a value stock, it needs billions in earnings to justify the valuation. We don’t think that’s happening.