Let me start off by saying that I have been bearish on Netflix (NFLX) for awhile now. The stock has looked overvalued to me for a long time, yet investors have continued to pour money into the name. I wrote a piece on Seeking Alpha about how Netflix does not deserve a $270 valuation a few months ago.
Since then, the stock has surged to over $250 a share and appeared headed for $270. That is, until the company announced earnings a few weeks ago. After a disappointing earnings report, the stock slumped about 10% and today Netflix trades at $229 a share. I still believe that the stock is severely overvalued, and the quarterly earnings bear this out. Sales are rapidly increasing for the company, but expenses are starting to eat into profitability.
The company has 24 million subscribers right now and will easily take out 30 million subscribers by the end of the year. Netflix is hoping to cross 50 million users over the course of the next few years. Even companies like Blockbuster are admitting that Netflix has a huge advantage in the streaming content industry. The problem remains that Netflix is seeing increasing competition from other companies, which is causing the online rental firm to spend more on content.
The company is increasing its operating losses estimates, upping them to $70 million because expansion is costing more than expected. The company is focused on expanding into international markets, which is causing the company to revise its earning forecast-only EPS between 93 cents and $1.15 per share. Analysts were looking for $1.18 as share. Therein lies the problem for Netflix. The company is adding subscribers but the earnings are flat.
Many analysts including Barclays' Douglas Anmuth and Michael Pachter of Wedbush Securities believe that streaming content costs are a rising concern for the company. Anmuth believes that streaming content could cost Netflix $2 billion next year. Pachter of Wedbush Securities says that content costs will rise by more than $500 million this year alone. That is an increase of $1.3 billion in content costs for next year.
Amazon (AMZN), Apple (AAPL), Hulu, and Facebook are all going to be competing for the same content as Netflix, which gives streaming content providers tremendous leverage against Netflix. Many of the company’s current deals are very short term and set to expire over the next few years. Netflix will find that the same content is a whole lot more expensive when the company tries to renew these deals.
The problem with Netflix is that everyone is too focused on top line growth. Revenue growth is quite impressive at the company, but the earnings growth is not going to keep pace. Netflix now trades at 51.5 times early, which is still too expensive for me to take a chance on.