Is The New York Times Right About The Risks Surrounding Netflix?

  • The New York Times recently ran a piece profiling Netflix and its long-term trajectory.
  • One Wall Street analyst claimed that Amazon would outgun Netflix due to Amazon's superior revenue base.
  • But are these claims accurate?

The New York Times Magazine recently ran an extensive article profiling video streaming company Netflix (NSDQ:NFLX). The commentary titled ''Will Netflix Survive in the World it Created'' featured views  of the company by chief executive Reed Hastings and a cross-section of Wall Street analysts. The article is quite different from many Netflix articles because it does not focus so much on subscriber growth rates or the rich valuation of NFLX stock, but rather on the seismic changes regarding consumer viewing habits. Although the piece carries opposing views on certain subjects pertaining to Netflix's future, it was by and large positive that the company remains on the right track to continue being the most dominant video streaming service on the planet.

That kind of endorsement might have come at the right time since Netflix stock has fallen like a house of card, tanking 25.4% year-to-date. Much of the hammering came post the first quarter earnings debacle where Netflix issued light subscriber growth guidance. Netflix said that it expects to add just 500k net U.S. subscribers during the current quarter and another 2M in overseas markets. The low expected subscriber growth has been attributed to Netflix's planned price hikes and ''ungrandfathering'' of older plans.

Netflix YTD share Returns


Source: CNN Money

Key Issues Raised In The NYT article

The NYT article highlighted Netflix's international expansion, which recently hit high gear from entering one or two countries at a time to 130 new countries all at once. Netflix now boasts more than 81M subscribers, and is looking to become a global phenomenon like Facebook (NSDQ:FB) in social media, Amazon (NSDQ:AMZN) in online retail, and Uber in urban transportation.

Many of Netflix's viewers are now millennials, with 25% claiming they have never subscribed to cable TV while the rest say they spend more time on Netflix and less on cable TV. Television viewing time dropped 3% in 2015, with 50% of that drop directly attributable to Netflix. Netflix is upending cable TV much the same way cable TV disrupted broadcast TV in the 60s and 70s. Mr. Hastings has predicted that linear TV will slowly fade from the scene over the next 20 years, much the same way mobile phones have gradually replaced fixed-line telephones.

Netflix has emerged as the video on-demand leader, and remains the favorite choice for many because (quoted from the post):

"Netflix is ABC, it is Discovery, it is AMC, it is USA and all the other networks,"

The company has been able to build an impressive original content library to supplement what it manages to license from cable services. For instance, Netflix has lined up more than 600 hours of original content for 2016 alone.

But here's the punch-line: just because Netflix has created a new world order in television entertainment does not guarantee that it will continue to thrive or even survive.

Rising Content Costs and Stiffer Competition

The article goes on to, correctly, state that Netflix's rapid international expansion and building out a vast library of original content has led to rising content costs for the company. Producing original content is very expensive, and a single show is likely to exceed the $30M  the company paid Starz to license its entire library of movies. Netflix has more than $12B in future content obligations with $5B planned for this year. As Wedbush Securities' Michael Pachter also correctly noted, Netflix's planned price hike is likely to lead to even higher content costs as its suppliers are likely to demand a bigger cut. Rising content costs is one big reason why Netflix remains in the red.

Meanwhile, Netflix has to compete for content not only against Hulu, which is now backed by four of the six largest cable TV companies, and Amazon, but is facing increasing resistance from cable suppliers who now view it as a threat to their own existence.

I have covered many of the issues that the NYT article raised in my past analysis of Netflix. But there is one bold claim made by Otter Media strategist Mathew Ball that I beg to differ with. The analysts claims that Amazon is potentially a big Netflix competitor based on the company's much bigger revenue base compared to Netflix's or even competing media companies. Mr. Mathew says that in a face-off with Amazon, Netflix would be outgunned.

I don't believe that this line of reasoning is accurate. To argue along those lines would be akin to saying that Amazon Travel poses a serious threat to Priceline (NSDQ:PCLN) and Expedia (NSDQ:EXPE) because Amazon has a much bigger revenue base than either of the two companies. Amazon Travel has been around for a while and has not been a problem for the two companies.

Amazon is first and foremost an online retailer while streaming video is just a secondary business for the company. Most of Amazon's investments go to expanding and/or improving its distribution channels including building out a network of warehouses and fulfillment centers. Meanwhile, Netflix is predominantly a video streaming company with the highest brand appeal in the industry. Amazon and Hulu are Netflix's biggest competitors. However, the battle between Netflix and Amazon is not as close as Mr. Mathews claimed. Amazon recently unbundled its streaming video service to help it compete better with Netflix. The service is a dollar cheaper than Netflix's standard plan and features some nice perks such as 4K content compared to Ultra HD programming by Netflix's $11.99/month Premium Plan. So the service definitely has some good potential.

But Amazon still has a long way to go before it can become a serious threat to Netflix. Sandvine recently estimated that Netflix represents 35.2% of Internet traffic in North America compared to Amazon Video with 4.3%. That's more than 8x bigger. Although the report seems to suggest that Amazon Video could be gaining market share at Netflix's expense, the reality is that Netflix now re-encodes its videos to deliver better quality and consume less bandwidth hence the drop in bandwidth share as measured by Sandvine.

Netflix currently sports a superior library of original content that is likely to take Amazon years to rival. But perhaps Netflix's biggest edge lies in its primacy in international markets where Amazon and Hulu are almost non-existent.

In a nutshell, Netflix investors should not worry so much about competition from Amazon and Hulu, but rather about the company's spiraling content costs. Mr. Hastings promised that the company will post the first material profits later this year. If Netflix is able to accomplish this milestone, then NFLX stock will get a much-needed reprieve. Netflix remains a good buy for investors with a long-term investment horizon.

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