Is It Time To Sell Netflix Inc. (NFLX) Stock As Subscriber Growth Concerns Rise?

  • Netflix is being hit by a changing video streaming industry.
  • User growth cannot continue at past levels.
  • Competition is not the problem says the CEO, then what is?

Netflix (NSDQ:NFLX), one of the world’s fastest growing streaming video services, has been going through a rough patch of late. After seeing its stock price grow tenfold in the span of a mere three years, moving from under $10 in 2012 to above $100 in 2015, the slowdown in subscriber addition hurt the company, causing the stock price to fall nearly 14% in the last one year. In fact, in just one day on Sep 21, Netflix stock price dropped from above $98 to around $94. It's slightly up again as of Sep 22 but the signs are not positive. So what's the problem, and is there any serious cause for worry as far as Netflix investors are concerned?

Possibly not, and I'll show you why.

Netflix is a video streaming company. Similar to a restaurant or a retail company, Netflix’s revenue growth will be affected by two factors: the number of users the company keeps adding and how much these are willing to tolerate price increases. Even if one of these metrics grows at a stable rate the company’s top line will improve. No company on earth can keep increasing prices without that taking a bite out of the user base. The best way forward is to keep their user base ticking, offer solid products that are wanted, keep the pricing power in hand and increase it as and when it is required. At the very least, a good product will allow the company to pass on increased costs to its customers and thereby protect its own margins.

Also read: Why Netflix Inc Stock Is Not A Good Buy Now

How is the Video Streaming Landscape Evolving?

But if you are a growing company and the number one player in an extremely competitive industry, your rivals who don't have as big a brand name have no choice but to undercut you on the price, thereby keeping you under intense pricing pressure. Under such circumstances, it’s nearly impossible to keep increasing your prices. The best way forward is to sit tight and keep working on user base expansion.

The growth of video consumption has brought way too many players into the market. There was a time when Netflix was the only big brand to offer premium video streaming services, but today we have Amazon.com Inc. (NSDQ:AMZN) in the mix with Prime Video, YouTube launched its own subscription service called YouTube Red and even Apple Inc. (NSDQ:AAPL) is trying to get into original programming through its Apple Music service. These are just the big tech brands, but there are several other players vying for a piece of the video pie as well.

Also read: Netflix Inc Cash Flows Are Severely Strained By Market Expansion

What investors will need to keep in mind is that the United States market is the proverbial Golden Goose. The moment they get any traction here, companies will up their investment and push harder than ever on marketing and customer acquisition. Most tech majors - especially retail-oriented ones like Amazon - cannot afford to sit by and watch a burgeoning video streaming market slip through their fingers.

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Why So Many Players in Paid Video Streaming?

The reason behind that is not merely additional revenues, although that alone is attractive enough. The real motivation is that tech companies today are creating ecosystems with multiple product and service offerings. When a customer switches to a particular product, it is because of related products and services that then fall within their grasp.

We’ve seen this over and over again. Why did Microsoft Corporation (NSDQ:MSFT) need LinkedIn (NYSE:LNKD)? So they can propagate their ecosystem to enterprise users. That ecosystem consists of not only Office 365, but also Windows 10 commercial subscriptions, Surface devices for employees, Skype Teams for collaboration and so on.

So, when one company offers a particular service, other big tech companies are forced to offer something similar or, if possible, even better. That’s why these companies are moving in groups towards new technologies and trends. Sports streaming is the latest craze, and Facebook Inc. (NSDQ:FB), Twitter (NYSE:TWTR) and Amazon all want a piece of it. Original video content came before that, and Alphabet Inc-C (NSDQ:GOOG), Apple and others wanted a piece of that. Virtual assistant is the biggest product-based development in artificial intelligence and deep learning so everyone wants to offer better and better virtual assistants.

The Case for Netflix Entering a New Phase of Growth in the U.S.

As far as Netflix is concerned it did not spark off a new industry; it was merely one of the earliest adopters. And it is the undoubted leader with 46+ million paid users in a country where there are only 90+ million broadband households. So yes, they will have a problem with their user base growth being slow after so many years. But one advantage they do have right now is the breadth and depth of original programming. The other is that they have not yet priced themselves out of reach of the mainstream market.

Also read: Netflix Inc May Be Losing The Plot In New International Markets

But going up from 46 million in the United States is going to start getting harder and harder because users who are new to paid video streaming now have so many options. It’s hard for Netflix to crack into Amazon Prime’s user base, and the same will be true of Apple’s when its original video content starts to build. But by that same measure, Apple and Amazon will find it very hard to break into the Netflix user base.

So Netflix isn’t showing a slowdown in subscriber growth because of increased competition, as CEO Reed Hastings told CNN when there were first rumors about Apple getting into original programming:

“Other people are doing shows too. HBO is doing shows, FX are doing shows ... so the fact that additional tech companies may be doing shows, that's really not that big a deal given the total number of shows being produced around the world."

What’s slowing them down is the fact that the video streaming landscape in their home market has irrevocably changed, and their own penetration is well above average. They will continue to grow, but not at the pace they set over the past five years. Netflix has embarked on a new phase of growth - one that is slower and more mature. But the overseas market is still wide open, and it remains to be seen how Netflix takes advantage of the fact that it is one of the few companies that has a presence in nearly every nation on earth.

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  • I am not an investment advisor, and my opinion should not be treated as investment advice.
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  • I do not have any business relationship with the companies mentioned in this post.
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