Netflix Inc.

Fundamentals

Written by Ophir Gottlieb, 10-14-2015

Netflix has earnings due out today after the market closes and while all eyes will be on subscriber growth as well as domestic margins (that's a key), for all intents and purposes, that very well may be missing the forest for the trees. With Netflix dropping a huge amount of content and movies and switching from just 10% original content up to 50%, if you really want to know where this firm is going in the long-term, it's content baby, and nothing else. With a 250:1 price to earnings ratio, the report on original content acceptance better be a smash success, or there will be blood in the streets. If not today, then soon.

In my opinion, Netflix will show fantastic growth, as surveys abound have shown that nearly 80% of new subscribers love the service. The company also rasied prices by $1 for new US subscnribers, and well over 70% of people polled would have no problem with a price increase. None of these are the story. The story is this:



Owning Netflix stock now is owning an investment in a different company than just a few months ago. These are the facts, and they are not disputed.

Netflix may be going through the largest pivot any large cap tech firm has gone through in a decade and the implications are huge. Further, the poor showing at the Emmy awards has reminded people rather abruptly that a content creator is a totally different company than a content distributor with technological disruption and Netflix simply is not the best in the world at the former, and its business is now moving abruptly in that direction.

While Netflix has become a colossal success by breaking technology in half as a distributor, forever changing the way we watch TV and movies. It has won the war, and fended off some very powerful companies to do so, making them look foolish in the process. But, Netflix is now relying more on original (exclusive) content than it used to as it has been dropping a substantial amount of other content.

In fact, Netflix just announced that thousands of movies will be removed from the US platform after not renewing a deal with distributor Epix. While NFLX points to the fact that so many other platforms already have the content so its not a competitive advantage (or need), oddly Hulu said "our subscribers have been asking us for more, and more recent, big movies" (Source: BBC News).



But this is the enormous pivot the company is making: "Today about ten percent of the content available on Netflix is either licensed or created by the company. It plans to increase that number to fifty percent" (Source: https://www.scottfearon.com/). Even though NFLX has done exceptionally well in this new realm, we simply must ask ourselves if the company's story is as compelling if it's an original content creator, rather than a technology disruptor through distribution. It's a fair question and one all shareholders should be asking themselves.

Content creation has some wonderful new revenue potential with syndication. But, it simply is not the same thing as being a technology company. It just isn't. Netflix is telling the world, "hey, half of our content is gonna be about us as a maker of shows, not a distributor." If it works, what a marvel this company will be (again). But if it doesn't, this company could easily become just an "app" on Apple TV (or wherever) and quickly fall out of the "must own" subscriptions in our daily lives.



What to REALLY Watch
We will get, perhaps in bits and pieces, some sort of read on the acceptance of Netflix's new shows. This friends, is the future. If acceptance is poor, Netflix is truly in trouble. Not existential trouble, but trouble that no longer affords the company a 250:1 price to earnings ratio. Subscription growth will slow and subscriber retention could plummet. But, if acceptance is strong, this is a company on its way to being worth $100 billion with feverish growth and an entirely new revenue stream.

Let's watch those subscriber numbers and those US margins. But if you want to know where this firm is going in the long-term, it's content baby, and nothing else.