Just over a month ago the Netflix share price plunged after subscriber growth slowed sharply in Q2, with the US market seeing a loss of 126,000 subscribers against an expected gain of 352,000. More worrying was a slowing in international subscribers to 2.83m, which fell short of expectations of 4.81m.
While management have suggested that the company’s really successful Q1 may well have caused some pull forward from Q2, and that the addition of new content, including Stranger Things and a new series of The Crown will see subscriber growth pick up again, the slowdown is worrying at a time when competition is heating up.
Apple and Disney to challenge Netflix
To highlight that confidence, Netflix have said they expect to add 7m new subscribers for Q3, which is quite a high bar, given the poor performance in Q2, and at a time when companies like Apple and Disney are ramping up their spending on streaming content with new offerings at the end of this year. This week’s announcement by Apple that they are set to spend $6bn on a host of new shows and movies is an ominous sign of things to come, as it looks to enter a market that they are clearly playing catch up in.
For years Apple TV has been an underutilised resource and often neglected in favour of the company’s main cash generators of the iPhone and iPad. Belatedly the company appears to be waking up to the fact that streaming video has the potential to be a lucrative revenue earner, however its biggest problem will be gaining traction in a market currently dominated by Netflix and Amazon Prime.
Netflix has helped set the pace for original online content in recent years, including series like The Crown, Stranger Things and Orange is the New Black, as well as a reboot of the Star Trek franchise, Discovery. In 2019, Netflix is set to spend $15bn in buying, producing and licencing content, an increase of $3bn from 2018, and herein lies the problem. Over the last five years the company has spent more than it takes in, meaning that its cashflow is negative, and as such needs to grow its subscriber base substantially quicker to compensate. It still has an impressive 151m paid subscribers, but it also faces losing the licensing rights to show some of its most popular content like Friends and The Office, as well as all of its Disney content once the licence runs out on that, and Disney Plus gets up and running, later this year.
As such the entry this autumn of Disney and Apple is likely to limit its ability to increase prices substantially to in order to compete. A current HD subscription for Netflix in the US is $12.99, compared to $6.99 a month for Disney, while the pricing for Apple TV+ is not yet known, and Amazon Prime costs $12.99 or £7.99 a month. In the UK the same Netflix HD subscription costs £8.99 with a premium one costing £11.99 a month. Fortunately for Netflix, Apple and Disney aren’t doing a global rollout quite yet, but the direction of travel is clear, and as such it can only be a matter of time before the new services get rolled out globally.
Netflix debt soars in battle to stay ahead
In looking to boost its market share and add new content, Netflix total debt has climbed from $2.37bn in 2015 to $13.7bn now, while revenues are expected to grow to $20.2bn for the current year end. Compare that to Apple, whose annual revenues are near to $260bn, generating $69bn in positive cashflow. In that context the sum of $6bn for new content is likely to be the tip of the iceberg if the company is serious about boosting the revenue it generates from services, as it looks to expand beyond the hardware of phones, Macs and tablet devices.
Disney is in a similar position in terms of scale, generating income from its studios, theme parks and resorts, as well as merchandising. Year-to-date, Disney is on course to generate $70bn of annual revenue, with net income of $10bn, and a positive cashflow of over $8bn last year.
So what does this mean for Netflix, at a time when a host of new streaming content options become available in the coming months?
On top of Freeview and the various options from BT, Sky and Virgin Media, we also have Now TV, Amazon Prime, and of course Netflix, and that’s before we even consider the new BritBox option that is likely to be launched in 2020 at cost of £5.99 a month, though it remains doubtful as to why anyone would pay extra for a product where the content can already be seen with a Sky subscription which includes Gold and W.
Most UK pay subscribers already have a combination of Netflix, Sky, and/or Amazon Prime, along with the free-to-air channels. It is hard to imagine there being an appetite for more than three subscriptions in a market that is becoming saturated, and where Netflix is already incorporated into the Sky Q delivery system.
At some point consumers will hit their limit in terms of cost, and that more than anything is likely to be the biggest barrier for Apple+ and Disney Plus, despite their deeper pockets, though they can afford to play the long game, given their multiple revenue streams. This is where they have a distinct advantage over Netflix, which only has a single source of income.
Short-term gain, long-term pain for Netflix?
For the moment Netflix is unlikely to be able to match Apple or Disney on pricing, but that shouldn’t matter in the short-term given its content levels are far superior when it comes to original content, while Amazon Prime appears to be going down the sports route, by signing deals for tennis and Premier League football, among others. Pricing becomes more of a problem the longer Netflix continues to spend more than it generates in revenue, and that could start to become apparent over the next year or so. Given it is already trading on a forward p/e of 94, it could be argued that a lot of the good news is already in the price.
Netflix does have the advantage of being already embedded in new TVs, which means as long as it hangs on to its content and grows its international subscriber base, it may be able to maintain its margins and stay ahead. That’s a big ask, especially if Apple and Disney decide to go down the same route and fund content in the same way, given that Netflix doesn’t own a lot of its content, but merely licences it.
One thing seems certain; the streaming market is about to get much more difficult for Netflix, and while the consumer is about to get more choice, I’m not sure how much of a good thing that would be if it's spread across multiple platforms. Sometimes you can have too much choice, and it seems likely that this could well be one of those occasions, which means in the years to come Netflix, among others, may become a takeover target for the bigger boys on the block, if investors start to lose faith in the sustainability of its business model. This isn’t likely in the short term with a market cap of $135bn, although it was only four years ago that the company was a third of the size it is now.
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