The last of the Four Horsemen is Netflix, a media distribution company that leverages internet connectivity and mobile devices. Streaming of video content has taken the world by storm and is now a significant slice of web traffic.

Traffic

Netflix, YouTube (owned by Google), Amazon Video and Hulu are examples of video streaming services which combine to make up c.61% of peak internet traffic. Consuming videos on demand, on multiple devices is what the consumer wants and this pattern of consumption will be here to stay.

 

One of the reasons for Netflix’s success has been the securing of off-the-run content from studios and networks on a long term, fixed cost basis. This means that each incremental subscriber adds directly to the bottom line with little additional cost. But the sourced content is not exclusive and the number of video streaming providers has exploded. Competition to distribute entertainment is fierce and rising, driven by both legitimate and shady sharing platforms. Netflix’s answer is original programming with House of Cards and Orange is the New Black prime examples of this. The company is ramping up quickly in 2016 by spending US$6bn to create 600 hours of content. For a company with US$7bn in sales last year this is a significant investment in future growth and, not surprisingly, Netflix will be borrowing in 2016 and likely for years to come.

 

The outlook for the shares relies heavily on Netflix growing its user base of 75mn and increasing pricing over time as programme production costs escalate. The new subscription video on demand (SVOD) business model is a lot less sticky in terms of retaining subscribers and, therefore, cash flows. Last year, management cited mass credit card expiries as a reason why US subscriber numbers came in weaker than expected which highlights the ease of service discontinuation either intentionally or inadvertently. US subscriber growth could slow because the company has already achieved a high penetration rate in the US, a crackdown on geo-hacking (where overseas viewers backdoor into the US version of Netflix), and the popularity of its future productions. Much hope is pinned on its international expansion to drive subscriber growth, but the fragmented nature of these smaller markets means that margins are unlikely to match that of its home market.

 

Net-net, we love the product but believe the stock is fully valued at present.

House of Cards

Is the Netflix share price a house of cards?

 

Felix Fok

Portfolio Manager

Disclaimer: This blog is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.