Why Netflix is a bad stock pick
Introduction
Netflix was a first mover in the streaming service and has since become more popular than individual traditional cable networks. During the pandemic, Netflix’s stock skyrocketed as the company acquired even more subscribers. However, I believe due to recent developments in the streaming industry, Netflix has become overvalued and therefore a risky pick for investors.
Summary
- Netflix business model is not sustainable in light of new competition
- Netflix’s valuation follows other tech companies, when it really is now a media company
Risky Business Model
Netflix was an unprofitable business until recent years. Currently, the streaming giant still maintains a low profit margin of 14.24% and holds on to more than 17 billion dollars in debt.
The reason for these poor financial performance is that their inherent business model is not the best for sustainability. Netflix used to spend billions of dollars on licensing content from studios and still continues today although a larger percentage is now spent on producing their own Netflix Originals content. In 2019 alone, 14.9 billion dollars was used to license content from other studios.
This goes back to the inherent value that Netflix brings to the consumer, which is just a platform where consumers can consume content that Netflix has licensed from other studios.This was fine in the last decade when there was not much major competition to Netflix’s business. However, with the rise of streaming services which are owned by studios that provide Netflix with its content, Netflix’s business model will likely not be able to keep up with competitors.
Tough Competitive Environment
The competition is fierce. For example, one of the competitors is Disney, which owns Disney Plus along with a major stake in Hulu. Disney also owns major studios such as Lucasfilm, Marvel, ABC, and Pixar. They’ve pulled off all of their successful content off of Netflix, and leveraged their brand to make Marvel TV shows exclusively for Disney Plus which have been wildly successful. Finally, users get a good bargain off signing up for Disney Plus because they get access to almost all of Disney’s vast catalog as well as newly released films.
AT&T’s offer with HBO Max is just as attractive. Users get access to a huge catalog of popular content from HBO and WarnerBrothers, including but not limited to Friends and Game of Thrones. And HBO Max is planning to release theatrical releases on the HBO Max platform right away. HBO Max offers a huge value to users as they could have access to many popular legacy content as well as the latest movies without going to the theatre.
AT&T and Disney are the main new players who have entered in the last 2 years and have a huge catalog of successful past hits. However, other TV networks like Peacock, streaming NBC’s content, Discovery+, and Paramount have all entered the streaming space. All of these entrances mean that many iconic TV shows and movies have been pulled off
from Netflix. For example, shows like Friends and The Office which are some of the most streamed on Netflix have been pulled off its catalog. Other shows include, That 70s show, Parks and Recreation, and Gossip Girl. Since virtually all TV and movie studios have their own streaming service, it is without a doubt that competitor studios will continue to pull out hit shows and movies for their own streaming service and leave their mediocre cont
ent for Netflix for meager compensation. In addition, if Netflix insists on keeping a particular hit movie or TV show from other studios, it will need to pay much more than before in order for the network to profit more from licensing to Netflix than putting it on their own platform.
Similarity to Media Companies
Netflix’s recent strategy has been creating its own content to compete. However, there is nothing special about Netflix’s platform compared to its current competitors. The only exception is its recommendation system which would have collected substantial user data gathered from the past decade. However, at the end of the day, consumers will switch away from the platform if the underlying content is not entertaining.Therefore, Netflix is much more a media company than a technology company.
Let’s take a closer look at Netflix Originals which are content purportedly made by Netflix. Netflix Originals and their successes are what most of the market is betting on in order to give Netflix valuation over 3 times compared to its peers. Although Netflix currently boasts that 35% of their catalog is currently made up of their Netflix originals, we can see that users still watch more licensed content. For example in October 2020, out of the 52 billion minutes of Netflix watched, only 3% of it were actually shows owned by Netflix. This is despite Netflix spending billions of dollars a year on financing content and making Netflix Originals over 35% of the catalog. Finally, competitors like Disney, AT&T, and Comcast who owned established studios have the edge here because they have a long track record of producing hit movies and TV shows. Netflix however, still doesn’t have a studio itself but instead invests in smaller studios for its production. This makes Netflix less equipped to compete on content with other traditional media companies.
Astronomical Valuation
Therefore, it’s more reasonable to consider Netflix as an entertainment company rather than a technology company. However, that is in great conflict with its high P/E ratio of over 60 which is even on the higher end of valuation for technology companies.The high P/S ratio of 8.54 also clearly shows that Netflix is valued like a technology company. Doing a comparable comps valuation to other publicly traded movie and entertainment companies reveal that Netflix has a P/S multiple that is valued more than 3 times more than the valuation of traditional media companies.This comparison is even greater when looking at Price to Earnings Ratio, which is valued almost 5 times as more.
So, there is nothing particular about Netflix that makes it better than its peers at producing engaging content. The extent of them being valued more solely on their content would only be on a few successes of their original content. However, that success is fragile because Netflix’s strategy has only been to invest in anything it sees and then using their brand and current user base to hopefully make it into a successful show. In addition, other studios also have more cash on hand to invest into future shows and the industry experience to make them successful.
Risks
However, there are some caveats to this thesis. Netflix’s valuation may continue to rise and further its current overvaluation because consumers remain loyal to their Netflix subscriptions even if they no longer find Netflix’s content engaging. For example, different studies show that 49% to 55% of Americans keep at least three streaming services. Subscribers might also stay even just for a few good content Netflix is able to put out. The combination of people’s forgetfulness as well as my belief that Netflix will still be capable of pulling off a few hit shows here and there makes Netflix’s decline a slow one. Regardless, although I wouldn’t recommend directly shorting the stock, the lackluster growth prospects in the foreseeable future affirms my belief that the stock should not be bought.
Although the company’s international strategy shows some promise and may undermine the investment thesis, Netflix is handicapped by their financial circumstances. Currently, the company’s strategy with international markets is to produce local shows that cater to the audience. This has been successful in places like India, South Korea, and Spain, where these shows were able to allow Netflix to further penetrate local markets. However, its continued growth is still uncertain. Many Asian countries already have established streaming services that will require Netflix to invest much more into producing local content. In Europe, a major company like Amazon is in a direct duoply with Netflix, which means growth is likely to be less dramatic for Netflix. Overall, the combination of competition from other streaming services as well as Netflix’s need to invest more into producing foreign content makes the possibility of a major international expansion less likely.
Conclusion
Overall, our firm’s prediction is that Netflix will see little to no growth at all in the coming years, and therefore we maintain a “Neutral” rating on Netflix (NFLX). The company’s business model is hardly sustainable in this extremely competitive streaming market, and its solution to make Netflix originals has not made a major impact in user’s entertainment choices while costing a huge sum for Netflix to produce. However, even if Netflix originals become relatively successful, I believe Netflix’s stock is still overvalued as a media company by looking at the Price to Sales and Earnings ratios compared to other traditional media companies who now have their own streaming services.
