By David Trainer, Kyle Guske II, and Matt Shuler
We’ve been bearish on Netflix /zigman2/quotes/202353025/composite NFLX +0.49% for many years, not because the firm provides a poor service, but because it cannot monetize content as well or sustain investment in content for as long as its competitors. Though the stock has only become more overvalued, our bearish thesis is proving truer by the day.
With its huge subscriber miss in the first quarter and weak guidance for subscriber growth, the weaknesses in its business model are undeniable. As a growing number of competitors take market share at a rapid rate, it’s clear that Netflix cannot generate anywhere close to the profits implied by the current stock price.
We think the stock at best is worth just $231 today – a 54% downside. And even that might be optimistic.
The new normal: Losing market share
Netflix reported just under 4 million new subscribers in the first quarter, well below its previous guidance of 6 million and consensus expectations of 6.3 million. Management guided for just one million subscriber additions in 2Q21, which puts Netflix on the lowest subscriber addition trajectory since 2013, or when Netflix began producing original content
Netflix can claim, as management did in its earnings press release , that competition didn’t play a large role in the subscriber miss, but market share data for the streaming industry indicates otherwise. According to a report by Ampere Analysis , a media and content analytics firm, Netflix’s share of the U.S. streaming market fell from 29% in 2019 to 20% in 2020. This chart shows Netflix lost a lot of market share and gained a lot of competitors in 2020.
We expect Netflix will continue to lose market share as more competitors enter the market and deep-pocketed peers like Disney /zigman2/quotes/203410047/composite DIS -1.28% and Amazon /zigman2/quotes/210331248/composite AMZN -0.07% continue to invest heavily in streaming. For reference, Disney+ expects to add about 35 million to 40 million subscribers a year through 2024, while Netflix, based on its 2021 trajectory (Netflix expects to add just 5 million subscribers in the first half of 2021), will only add around 10 million subscribers per year through 2024.
The streaming market is now home to at least 14 streaming services with more than 10 million subscribers. Many of these competitors (like Disney, Amazon, YouTube (owned by Google parent Alphabet /zigman2/quotes/205453964/composite GOOG -0.64% /zigman2/quotes/202490156/composite GOOGL -1.34% ), Apple /zigman2/quotes/202934861/composite AAPL -1.01% , Paramount /zigman2/quotes/200340870/composite VIAC -0.40% and AT&T’s /zigman2/quotes/203165245/composite T -0.31% Warner Bros.) have profitable businesses that can subsidize lower-cost streaming offerings and permanently reduce Netflix’s subscriber growth potential.
Top-line and bottom-line pressures
We underestimated Netflix’s ability to raise prices while maintaining subscription growth because we expected competitors to enter the streaming market sooner. But now that the competition is here, our thesis is playing out as expected. As a result, consumers have a growing list of lower-cost alternatives to Netflix and may not be as willing to accept price hikes going forward.
Increased competition hasn’t only hurt subscriber growth, market share and pricing power. It also raises the costs for the company to produce, license and market its content.
At the same time, Netflix is paying more than ever to acquire subscribers. Marketing costs and streaming content spending has risen from $308 per new subscriber in 2012 to $565 per new subscriber over the trailing 12 months (TTM).
For a user paying $14 per month in the U.S., it takes Netflix over three years to break even. It takes nearly five years to break even on international users, where Netflix is seeing the most subscriber growth.
Competition creates a Catch-22: Growth or profits, but not both
Netflix’s free cash flow was positive in 2020 because the firm cut content spending. But not growing content spending in 2020 resulted in subscriber growth cratering.
So Netflix plans to spend $17 billion on new content in 2021….but will it work? The data suggests “no” and that throwing billions of dollars at content will not be enough to fend off its competition.
Here is where Netflix narrative breaks down: the content spending cuts needed to be profitable prevent Netflix from achieving the scale (i.e. number of subscribers) needed to justify its lofty valuation.
So far, spending billions on original content may win some awards, but subscribers still like licensed content more. For example:
Just 3% of viewed minutes was spent on Netflix-produced shows