Netflix and Chilled Growth

By, Robert Moss

From its humble beginnings sending people DVDs in the mail to being a multi-billion dollar streaming company trading at 132.0x earnings, Netflix has experienced a meteoric rise. Their service has irreversibly transformed the way people consume media. However, in a heightened competitive environment, can they sustain their prolific growth?

Back in August, Netflix reported their Q2 2019 earnings. Revenue grew by 25.0% from Q2 2018 to $4.9 bn, gross margin was flat at 38%, and operating margin increased from 11.0-14.0%. A lot of companies would kill for that type of growth and those high margins, especially at Netflix’s size. Earnings muddied their quarterly performance with net income falling by 29.0% to $0.2 billion and net income margin decreasing from 9.0-5.0%. Probably upsetting Wall Street the most was the company missing their guidance of 4.9 million net new international subscribers, only pulling 2.7 million for the quarter.

The market reacted negatively, with Netflix’s stock shedding 11.0% of its value on 17 July 2019, the day after the report was released. Since then the stock has declined from the $365.99 the day of the release to to $265.92 as of this Monday.

Over the last few years Netflix has pursued a strategy of aggressively developing their own content. As more competitors enter the streaming market, they’re trying to differentiate themselves instead of relying solely on license agreements. With their most popular TV shows like Friends and The Office leaving Netflix in the near future, the California based company’s strategy has been somewhat validated.

However, the issue is they’re fueling this strategy with massive amounts of debt. They added $2.0bn in debt in Q2, bringing the total to $12.0 billion on their balance sheet. Their debt-to-assets ratio is 125.0% and their debt-to-equity ratio was 67.0%. Let’s not even get started on their current ratio.

The point being, Netflix is pursuing a high risk strategy with their debt levels. Creating a hit movie or TV shows at the level of Friends of The Office is a little less than outright gambling. None of this is new information. Investors have eagerly fueled higher price multiples based on Netflix continuing — what seemed like — relentless subscription growth. The US market is widely considered saturated at 60.0 million current subscriptions. Investors have been looking abroad, betting big on international subscription growth which currently has 90.0 million subscriptions, far short of the total addressable market.

Disney+ is often used as a foil to Netflix given the large plethora of content Disney has at disposal for its streaming service, but there’s lots of other non-sport streaming competitors currently in the market like Prime Video, HBO Now, CBS All Access, YouTubeTV, Hulu, SlingTV, and Playstation Vue. In addition, more are coming to the fore like AppleTV, AT&T TV, and Peacock (by NBC Universal). With all of these streaming services targeting the US market and Netflix’s saturated position, it raises concern whether they can increase their domestic subscriber base or exert significant pricing power.

Q2 served as a dent to the Netflix bull thesis. In the coming months, international subscriber growth will be more important than ever as the US streaming market heats up. With the launch of Disney+, it will be interesting to see how quickly other American streaming services can expand internationally and what that means for the longevity of Netflix. 

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