In our previous article, we discussed why Netflix, Inc. (NFLX) is still overvalued, even after the recent dip of about 6%, which came as a result of Amazon.com, Inc. (AMZN) signing a three year-3,000 titles deal with EPIX, a provider of content from Viacom Inc.'s (VIA) Paramount, MGM and Lions Gate Entertainment Corp. (LGF). Friday will see the license of another content provider - A&E Network - to NFLX expire.
According to reports, NFLX intends on keeping 200-300 hours of content from A&E, while dropping around 800 hours since it has not acquired enough viewership to justify costs. Due to a challenging future outlook in terms of competition and costs, we continue to advise against a long position in the stock, regardless of the recent dips.
While content expiration is a regular thing for streaming services like Netflix, what is worrying is the ability to pay for or renew these deals; Netflix was not able to renegotiate a deal with Starz to provide movies from Disney (DIS) and Sony, earlier this year. A more important point is whether NFLX will be able to get exclusivity for its content deals with A&E, or other networks, when competitors are willing to pay more for the same content. Non-exclusive content can be offered by competitors at lower prices as compared to NFLX's subscription fees.
Content providers like Time Warner's (TWX) Warner Bros, Disney, and CBS Corp (CBS) are clearly benefiting from the competition amongst streaming services that buy their content - these range from those by Apple (AAPL) to Amazon. There is always the option for content providers to offer content direct to customers by making appropriate investments.
Netflix, meanwhile, has continued to try and improve subscriber experience with a new version of its app for the iPod and the iPhone, with features like payback, and more personalized recommendations. However, we think that content is the primary differentiator in NFLX's industry. Better content will determine which service does the best business.
Although the stock price has mainly been responding to the threat from Amazon, there are other services that might affect NFLX in the future, albeit not as significantly as Amazon or Hulu. One such service is the Verizon Communications (VZ) and Redbox collaboration - Redbox instant by Verizon, which will be offering streaming and DVD through Redbox's 36,800 kiosks later this year. The pricing and content deals have yet to be disclosed.
Coinstar's CEO has said that it does not want to compete on the basis of number of titles. Movies are expected to be the main focus. The Redbox kiosks business is slowing, so the company is looking to revenues from streaming as well. Netflix is one company that could lose its market share (even though we do not expect the effect to be huge) due to this soon-to-be-launched service. Other companies like Dish (DISH) and Comcast (CMCSA) also offer competing streaming services.
Competition can also be expected in Canada, a market that NFLX penetrated faster than the U.S. BCE Inc (BCE), a Canadian telecom, plans to have an online service along the lines of Netflix, so that it can utilize its recent investment in Astral Media Inc., as well as entertainment, news, and sports content under Bell Media. NFLX fell 1.3% in response to this news on September 10.
Historically, Q4 is the period with the most net subscriber additions, followed by Q3. Part of this could be because of students going back to college. However, the company has already guided to a Q42012 loss, owing to international expansion. There is no indication of profits from international operations so far.
Analysts continue being unimpressed with Netflix. On September 17, Macquarie initiated NFLX with an underperform rating because of weak subscriber growth, which was below guidance, and very high costs for expansion into Nordic areas, in addition to Netflix being a price-taker for content. The target price given by Macquarie is $50. NFLX's stock price fell by more than 5% on the news.
The average P/E for Netflix over the last five years has been 35x. At forward P/E of 60x and EPS estimate of $0.92 for 2013, the valuation comes out to be $55. The 52-week low is $52. The forward P/E multiples for Time Warner, Dish Network, and Comcast are 12x, 12.5x and 16x, respectively.
It would not be prudent to buy NFLX based on the huge stock price decline over the last few months, as there is still some downside left. The future outlook remains challenging, as the bottom line will keep facing pressure from international operations, while the competitive edge (e.g. content) that NFLX had over other streaming services slowly disappears. Going forward, subscribers of multiple streaming services at one time will have less reason to subscribe to NFLX as well, when the content offered by other services is the same, if not more.