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In the United States, the average household has access to 189 TV channels, yet it only watches 17.5 of those. When it comes to on-demand video streaming, the average American is subscribed to 3.4 services. One of the key determinants for success in the streaming business is quality content. In this article, we’re questioning if Netflix’s content, as well as market position, can justify its stock price.
At the start of 2019 (when NFLX was trading at $350/share), we published a very short article stating that it will underperform all the other FAA(N)G stocks. It declined by more than 25% since. That could, amongst other reasons, also be due to the inflow of competition. The days of being the only choice are long gone, and now it will be competing with Apple, Amazon, NBC Universal, Warner, Disney, and a few more.
Netflix remains to be the only outlier in the FAANG group. Unlike the others, it is neither wildly profitable nor does it have a MOAT. Google, Apple and Facebook are all wildly profitable, and Amazon has a moat in the online sales market. The question, what does Netflix have that its competitors, filled with pockets full of cash, can’t get?
Netflix continues to be valued as a technology company. It’s an ongoing debate as to whether the incoming competition will lead to Netflix being valued as a fast-growing media company instead. Netflix does tick 4 of the 5 essential tech categorization boxes. It delivers shows at zero marginal cost (some bandwidth of course), it serves a large user base by utilizing software, it has zero transaction costs due to a self-serving model, and the product improves over time. It however does not have a real software ecosystem, which we believe is essential for a technology company with their valuation.
How about raising prices?
If competition is sparse, raising prices is relatively easy. If your competition consists of cash-rich tech and media giants, some of which have great content libraries, it becomes more difficult. The average spend on streaming services in the US is $8.53 per subscription. Netflix’s most popular plan increased its costs to $12.99 per month earlier this year. Any further increase in prices will now become unlikely, as lower-priced alternatives re-define the value of content streaming. Though a person may choose to hold multiple streaming subscriptions, the primary reason for cancellations remains to be a perceived incorrect price to value ratio. The risk of churn when raising prices is too high, especially when new subscriber growth is a key metric supporting the stock valuation.
In the end, content is king.
And this is what it all comes down to. The quality of the content. Netflix has been hit with hit TV shows “Friends” and “The Office” leaving them. They had to sign Seinfeld, a statistically less popular option, for a price higher than both Friends and The Office combined (>$500 million). If content is becoming more expensive, and pricing becomes more competitive, when will investors start looking at the fundamental numbers? If they start doing so, it will be dramatic for Netflix.
What will happen?
This is not a prediction for the company. It is undeniable that Reed Hasting is a highly intelligent CEO, and that Netflix as a company will stay around for a long time.
Netflix remains to have a variable cost for expansion and can still tap further into international licensing opportunities as opposed to subscriptions only. Netflix has the opportunity to become financially healthier, regardless of its competitive environment.
The recent junk bond issue does not signal any warnings. In the current interest rate environment, who is to blame them for issuing a bond that allows them to focus further on their content library. The only point of caution that Countach Research wishes to share, is that investors should consider as to whether a media content company should be valued as a revolutionary tech company, or just a rapidly growing media company.