Netflix Holds On, But Where Does It Go From Here?

| About: Netflix, Inc. (NFLX)

I recently canceled my Netflix (NASDAQ:NFLX) subscription. While the stock has looked pricey for a while now, I at least liked the service. At $8 per month, the service is highly affordable. I was pleasantly surprised that cancellation was a breeze (as is rejoining). This speaks to good customer service, which is a big positive. But that alone is not enough to keep me as a subscriber.

So why did I cancel?

  • Netflix removed some of the old shows my children liked to watch.
  • Amazon (NASDAQ:AMZN) Prime offers incredible value -- I buy a lot on Amazon, and the two-day free shipping in most cases was a big draw. And they have a better movie selection, at least for my taste (I watched "The Hunger Games" on their streaming service recently; it is not available on Netflix). I believe that the reason more people haven't subscribed to Amazon Prime is that they haven't figured out what a great deal it is, or maybe the one-time price of $79/year is more of a sticker shock than is the $8/month charged by Netflix. I think Amazon Prime could easily move to $10/month pricing and still be a far better value than Netflix. Part of the problem has been that they have not advertised their service as aggressively as Netflix did, but once people catch on, expect this to cut into Netflix's subscriber base.
  • I get additional value from my Comcast (NASDAQ:CMCSA) subscription. Yes, most decent movies cost money on the Comcast service, but it's the movies I want to watch and the selection is more current than Netflix's. And my Comcast subscription allows me to access over 500,000 Wi-Fi hotspots for free (and I do).
  • Binge viewing might attract teens and young adults who have large blocks of time to devote to watching TV, but most of us adults simply do not have the time to watch for hours at a time. Netflix stock has been on a tear this year, boosted in part by big-name investors coming into the stock, and strong subscriber growth. The question now remains: Where does the stock go from here?

In short, I canceled not because Netflix's service isn't adequate (at $8/month), but I found better value elsewhere. What this means is that Netflix's market will not go away, but rather that it's more limited than most people realize. It is the most visible company in the streaming space, but unless they innovate or offer additional value and services, they will a) lose subscribers, and b) reduce their pool of potential customers. There are at least two ways to do this: offer better content and/or offer additional services à la Comcast and Amazon.

At price levels of ~$400 per share, the upside is limited unless their value proposition changes dramatically. Conversely, the downside is considerable, for the following reasons:

  1. U.S. customer growth will slow, as more options become apparent to subscribers.
  2. The international market is undoubtedly huge, but local restrictions can lead to a weak library and high costs, and better-financed competition will hurt growth.
  3. The cost of creating or buying programming is high for Netflix, and is likely to continue to be so.
  4. Expect the recent ruling on net neutrality to have a material negative impact on costs.
  5. Sale by any large fund, particularly Icahn Jr.'s holding, will cause a substantial drop in price.
  6. CEO Hastings thought the stock price was frothy a couple of months ago, when the stock was trading below today's levels. Nothing materially has changed for the company since then, and his newfound bravado on the recent conference call is scary. When CEOs believe their own hype, bad things happen. We've seen that movie play out time and again.

So, to answer the question posed in the title, I think we can certainly go higher from here. However, the risk/reward clearly favors the downside. A haircut of 20%-50% is not inconceivable, as investors get more attuned to valuation and the company's limited prospects, or when the company begins to show signs of not being able to grow into its valuation. The move down will be violent and rapid.

Disclosure: I am short NFLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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