Why Netflix Badly Needs To Diversify

  • Despite rampant piracy, Netflix has managed to increase its user base significantly.
  • Original content production costs are high while ROI is questionable.
  • For Netflix to flourish moving forward, it must diversify or prepare to fall behind.

In an era where content piracy is on the rise, Netflix (NASDAQ:NFLX) has managed to increase its user base and receive a string of Golden Globe nominations while at it. It is a time when a cloud-based media offering can go head-to-head with the likes of HBO and come out on top.

With approximately 45 million members in the US alone, one would think that Netflix would be able to dominate the premium content streaming industry. However, in Q4 2015 Netflix's subscriber growth rate slowed down (1.6 million subscribers added) and actually fell short of the expected 1.62 million additions. On the other hand, Amazon Prime, which comes with Amazon Prime video, has 54 million subscribers in North America. However, it is worth noting that all Netflix does is stream content. Whereas Amazon is a giant of a company which uses content among other things like free shipping, as a part of its Prime offering to attract customers to its lucrative e-commerce offering.

That said, the fact is that Amazon is playing in an industry which gets more competitive by the day. With a plethora of streaming services, one wonders how long Netflix can use its brand to spur growth for. In a move aimed at firmly laying the foundation for the long term, Netflix is producing more original content so as not to get involved in a subscription price war.

For instance, Netflix spent $12 million acquiring the rights to "Beasts of No Nation" but it went on to rake in just $90,777 at the box office. From Netflix's point of view, that is the cost of building a library of original content, and that is partly the issue. You see, Netflix will spend $6 billion on content this year. Netflix is aiming to significantly increase its user base in each of the about 190 countries it is present in, to build a dominant streaming platform which will last long into the future.

Interestingly, that is a huge gamble. And considering that Netflix has only one revenue stream i.e. premium content streaming, one cannot help but think of the age-old adage of not putting all of one's eggs in one basket.

We are already beginning to see signs that in the future, diversification of content types in any streaming service will be critical. For example, music streaming service Tidal also launches events, gives subscribers access to exclusive editorial content and has exclusive album launches. Plus, they are moving to making live content exclusively available to consumers.

With so much content being produced, streaming providers such as Netflix will have to work harder in order to keep its subscriber base satisfied and stave off competitors.

Competition

It is fair to say that Netflix pioneered the a-la-carte model of content syndication. For instance, prior to launching into the streaming market, they were famous for posting DVDs and providing subscribers with unlimited deliveries of their favourite movies and tv shows.

Fast forward to now and Alphabet Inc-C (NASDAQ:GOOG) has launched a disruptive streaming product with Youtube Red. It provides an ad-free Youtube experience, unlimited access to 30 million songs, and exclusive content from top Youtubers for $9.99 a month. Likewise, an Amazon Prime membership includes access to a range of tv shows, movies, music, free one-day delivery, and other perks for $99 a year.

What Amazon has done, is made content a perk, rather than building an entire business around it. What Netflix could do is to use streaming as its core offering and then leverage that to establish other revenue streams such as screenings exclusive to subscribers, a music streaming offering, exclusive concerts, etc.

Stock performance

Netflix trades at approximately 350 times earnings with little justification. The fact is that investors seem to have a lot of faith in the long-term potential of Netflix, much like they do with Amazon. We have seen this in the case of Yahoo, and the fact still remains that today, it is challenging to scale a business based on content alone.

More recently, possibly also partly due to the weakness in broader markets, sanity has prevailed and Netflix shares have declined by about 25% in just 3 months. That's what can happen at these valuations.
NFLX stock price chart

Netflix stock price chart by amigobulls.com

The Netflix model isn't sustainable and this is evidenced with a net profit of 2.4% in Q4 of 2015, and an average of 3.1% over the past 3 years. And this is despite a compounded annual revenue growth rate of 23.4% over the past 3 years.

Conclusion

In conclusion, some investors still choose to remain bullish/hopeful on Netflix stock. However, the numbers simply don't add up, and with giants such as Amazon and Google on its tail, the Netflix stock simply doesn't look like a wise investment decision.

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