Talking Stocks: Netflix Inc.
Updated: Feb 8, 2020
While there are dozens of video-streaming platforms, building a brand strong enough to go viral and sustain user satisfaction is no walk in the park: suggesting that any company which achieves this feat is one that shouldn't be doubted.
Our second Stock Pick of the Week is a business that’s tremendously grown since its inception: blowing competitors such as Blockbuster out of the water and consistently augmenting its share of the streaming market as the years continue.
There’s undoubtedly a financial storm surrounding this company at the moment, which is supremely why opening a position NOW may hold significantly positive consequences for you in the future. Thus, here’s why Netflix, Inc. is still a strong BUY:
First Mover Advantage
Recently, Netflix and their stock price have been a victim to the threat of rising competition from The Walt Disney Company and Apple TV: both of which triggered panic-selling and – along with slightly disappointing Q2 results – caused Netflix to suffer a 20% drop in their share price as of July 2019. This is a reaction that could be perceived to be slightly exaggerated.
While the prospect of undercut prices from these two financial powerhouses may mean that Netflix subscriptions will be categorized as potentially “expensive”, the fact that Netflix were essentially the first real territory-marker in the streaming industry gives them a cachet that relatively protects them from the threat of rising competition.
This is partly because Netflix users are statistically proven to be extremely loyal: with over 70% of subscribers on average claiming that they would watch the next season of a Netflix show that they just finished.
In contrast, Netflix competitors yield a rate of merely 38% of users on average willing to watch the next season of a show. If the validity of this statistic persists, then Netflix are inarguably far ahead of its competitors due to being first in the market, and the advent of more streaming services in the industry only means that Netflix's advantage has gone from being 5 years ahead to 2 years.
2. Value of Original Content
In 2018 alone, Netflix invested over $12 billion in producing original content: something that no other streaming service has ever looked at as a winning strategy before. While a majority of potential investors might see this as frankly irresponsible cash burn, looking at the bigger picture may actually uncover Netflix’s rationale; and there are two reasons why it should be considered a winning one.
a) Originality gives Netflix a Unique Selling Point (USP)
Significant expenditure on original content undoubtedly gives Netflix the ability to retain premium charges and perhaps even facilitate price increases every now and then: in other words, a USP. This is because the value derived from original content far exceeds solely streaming other distributor’s shows, and this is statistically evidenced through the performances of shows such as Money Heist and Stranger Things.
Money Heist’s third season was produced and distributed solely by Netflix: a decision that proved to be incredibly valuable shortly afterwards as the show gained 34 million viewers within the first week, and subsequently, tens of thousands of new subscribers. Similarly, Stranger Things is also one of Netflix’s frontrunners, bringing in over 26 million views in its first week with Season 3. Moreover, this even more significant because Forbes found that over 14% of ex-Netflix users ended up re-subscribing to watch the latter show’s latest season.
Sub-brands such as these are what act as consistent revenue generators for Netflix because they facilitate the potential to gain more subscribers, which inevitably translates to greater earnings. Consistent production of such desirable, original shows are what separate this distributor from others: a key aspect that suggests Netflix’s future is bright and subscriber counts will augment with more high-quality productions.
While bearish investors tend to heavily regard financials, looking at the bigger picture of Netflix's potential like this may alter the more pessimistic outlooks regarding this equity.
b) Word-of-mouth and its direct impact upon revenue
Investing such substantial amounts of capital into high-quality, original content is also an impetus into gaining revenue because positive reviews facilitate word-of-mouth, which brings upon a chain of events that leads to more viewers and essentially, more subscribers. Because of this, it can be implied that critically-acclaimed films which can leverage word-of-mouth will be a beneficial revenue generator for Netflix.
Consider the example of Sandra Bullock’s film, “Birdbox”, from last year. This asset was viewed over 90 million times on Netflix, and was so positively received by viewers that it brought in over $30 million in new subscribers: of which 70% joined due to referrals. The fact one film was able to bring in such a substantial amount of cash speaks to the potential that Netflix attains, and is supremely why the term “asset” was used to describe it. An asset is simply defined as an owned product that essentially puts money in your pocket, which concretely describes productions like Birdbox as it alone brought in almost 2.2 million paying subscribers within several weeks: i.e. Money. Pocket.
Therefore, it’s inescapably clear that Netflix’s heavy investments into original content elevate their branding, which allows them to benefit from word-of-mouth and also create monetarily beneficial assets. This is why their consistent revenue generation is likely to only go upwards from here; with the potential to grow exponentially more if Netflix series and films achieve commendable wins at the Emmy’s and Academy Awards respectively.
3. Cash Flow Outlook
Although Netflix’s cash flow has always been an issue for investors, future estimates tend to be quite optimistic, which is extremely significant because the level of free cash flow in a company is what essentially drives stock prices in the long term.
CEO Reed Hastings said in an excerpt of an interview that “at a larger revenue base, original content expenditure will be slower, after which we anticipate substantial positive free cash flow, like our media peers.”. With the annual growth/profit levels that Netflix have achieved recently (shown below), an even larger revenue base seems feasible in the near future and therefore suggests that the streaming giant will soon be able to gain positive cash flow, thus exuding themselves as a reliable investment.
Figure 1: Netflix Inc's Revenue Growth since 2002
Although undesirable to the company, another path towards generating greater cash flows would be the introduction of advertising. This almost acts as an insurance policy for the Netflix today, as they possess the ability to introduce ads but are withholding from it due to their prioritization of user satisfaction.
While this remains true to their organizational vision, the real questions are: how long can Netflix go without generating more income streams, and do 30-60 seconds of ads really harm user experience in the long run? Well, research depicts that 98% of all YouTube videos begin with ads, yet we as consumers still regard the merits of using the platform greater than the minor inconvenience of ads. Because Netflix possess a similar and desirable brand image, it could be implied that short ads will seldom affect user satisfaction, which therefore gives the company a direct access to significant levels of cash.
Cash is truly king to sustain profits in the entertainment industry, and while I believe that Netflix will attain positive free cash flow in the near future without ad revenue, leveraging it would certainly expedite the entire process.
While the notion of some financial heat from the Disney+ platform as well as Apple TV have spiraled investors into panic selling Netflix stock, you can see that the company clearly still possesses the potential to augment their share prices and business growth in the near future.
Despite the advent of increased competition, Netflix’s substantial investments into original content speak towards their dedication to sustaining a powerful brand image: both of which create the potential to retain current subscribers as well as incentivize more to join. Moreover, if Netflix's productions can secure several Emmy and Oscar nominations within the next year, the company's ability to become profitable may not be doubted as much as it is by critics and investors.
Therefore, by using their "First Mover" advantage to continue producing desirable content and retain subscribers, Netflix Inc. inarguably seem like they are on the trajectory towards greater growth in both cash flow and share prices.