Netflix: why one shouldn’t buy its shares and what the company’s future is like

An expert: despite good financial digits, tough years await it

Netflix (NASDAQ: NFLX) turned from a small DVD rental store into the leader of the world market of streaming services. But the picture isn’t so rosy from a perspective of the company’s further development: its shares are overestimated, thinks Realnoe Vremya’s columnist, economist with long-time banking experience Artur Safiulin. In the next column for our newspaper, the expert explains the reasons and fixes a reasonable price for the company’s share at $230-250, not today’s $528. The story of success of the past doesn’t guarantee rates will grow in the future, this is what brokers’ websites write. And this applies to Netflix, he is convinced.

A bit about the company’s development history

The company appeared in 1997 when its founders decided to test a new model of selling and renting DVDs, on the Internet. A client could see a film catalogue on the website and get and return them by post. The store was designed to be completely virtual. The idea turned out to be successful, and large advertisers started to be interested in the company soon. So Toshiba offered a free rent of three Netflix DVDs for buyers of its new DVD recorders. They were followed by Pioneer, Hewlett Packard, Apple, Sony. The number of Netflix subscribers increased together with soaring recorder sales. After a repurchase offer from Amazon (the owners declined it then), the company refused to sell DVDs and totally focused on rental (by expanding the film catalogue, buying film studios’ rights) and the creation of a system of film recommendations based on the search history, ratings and users’ reviews.

In 2003, the company was listed by NASDAQ at $15 per share, after that, its rates steadily grew. By 2005, the number of subscribers reached 6,5 million, while Netflix daily sent a million disks to its subscribers. The progress in a higher Internet and video streaming speed in particular allowed the company to launch a streaming service in 2007, which gave its clients a chance of watching films and shows anytime (the so-called on-demand format). The subscription model is a fixed monthly rate for unlimited access to the content. Firstly, one could watch just a thousand films and TV shows. To compare, the company’s online catalogue had over 100,000 DVDs. Nowadays the number of the company’s subscribers has totalled 208 million people, and the service offers series, feature films and documentaries of different genres and in different languages in 190 countries of the world. Apart from buying content from other producers, the company makes its own, which it has already received awards for (this year, the 36th Oscar nomination among distributors). The pandemic brought about 30 million new subscriptions.

Current situation and stock market

After the record year in 2020, the growth pace of the number of subscribers suddenly decreased. In the first quarter of 2021, the service registered 4 million new clients (the number of 6 million was mentioned in public plans). The company forecasts to attract just a million new subscribers in the second quarter (which is the level of 2013 when the company launched its own content). The slower pace is caused not as much by the cancellation of lockdowns as by the activity of rivals in the person of Amazon, Disney, HBO Max that are seriously increasing their clientele and investing in the purchase and production of foreign content. Netflix grew slower than the same HBO Max even in the USA in the first quarter of 2021.

A fall in the growth of the number of subscribers is the only scheduled indicator the company hasn’t achieved. Generally speaking, the financial situation is stable. The results of the first quarter of 2021 are good. Revenue in particular totalled $7,16 billion (24,2% more compared to the analogous indicator in 2020), profit is $1,71 billion (140,7% of growth), earnings per share were 3,75 (+133,85%), net income amounted to 23,83% +93,9%).

The stock market loves such success stories, and the dynamics of capitalisation growth since 2016 are impressive: from $97 in July 2016 to $528 per share in July 2021, which is about a 444% rise, that’s to say, by 90% on average a year. The company is in the so-called FAANG (the five prominent American technology companies together with Facebook, Amazon, Apple, Alphabet (Google)).

Seemingly, the company is starting to get tired, and the rates were in stagnation in the last six months. Many experts believe the share is overestimated, and here is why:

  • New players are rapidly cornering the market. Netflix’s share in the USA dropped by 9%, while the number of big rivals in the market rose from five to seven in a year alone, from 2019 to 2020. The companies with big wallets — such as Disney and Amazon — are investing huge money to develop streaming services. For instance, Disney is planning to attract $35-40 million new subscribers annually through 2024. They can really crowd out Netflix from the first position in terms of the number of subscribers, now Disney has 146 million people.
  • A big problem is that key rivals have parent tycoons behind that can subsidise lower prices for subscriptions. It is a big question how long Netflix will stay in such a war. An expansion of the clientele was the only source of the company’s growth because it is impossible to raise subscription rates for clients — this threatens with a bigger loss of the market.
  • Great activity of its opponents makes the business more expensive — marketing expenses have doubled in the last two years: the price for a third party’s content is going up (producers give more to those paying more, it is the rule of the market anyway); its own content production costs are increasing. All this leads to a situation when costs on an average user in the USA (with a $14-package a month) pay back only in three years. The term in other countries is five years. We should keep in mind that the number of subscribers is growing mainly around the world, not in the USA.
  • There is another paradoxical moment: the company managed to save a positive free money flow (the money after operating profit). To put it simply, to be profitable by cutting its own content production expenses, as a result, the rise in subscriptions fell. Now Netflix plans to invest $17 billion in production, but it seems time is up, and the efficacy of these costs will turn out low. This is another brick in a boat of growing expenses.
  • The market’s current evaluation is based on the assumption that the company will get new clients, that’s to say, it will grow in size. But the necessity of remaining profitable makes it control production costs and doesn’t let the company “grow” (what investors and the market expect). This is the dilemma of Netflix nowadays. As soon as the market understands that the endless growth is over, there will be a significant correction to the company’s shares. And a 50% fall isn’t the end, in fact.

It would be logical advice considering all the above-mentioned to stay clear of this issuer. 2021 will be decisive for the company — the rates aren’t going to rise, while a correction is possible according to the company’s performance. It will be interesting to see if such a forecast is confirmed.

Artur Safiulin
Reference

The author’s opinion may not necessarily coincide with the position of Realnoe Vremya’s editorial