The Competition Could Hammer Netflix Stock
Netflix, Inc. (NASDAQ:NFLX) is a market darling. But can the company meet the lofty expectations priced into Netflix stock or is it another bubble about to burst? I would argue it’s very much a case of the latter—and for good reason.
After market close on Wednesday, the video streaming company released its third-quarter earnings report. Top-line revenue numbers weren’t bad. Last quarter, Netflix grossed $1.74 billion, up 24% year-over-year and roughly in line with what the Street was expecting.
However, problems started to show up further down the income statement. According to analyst estimates compiled by Reuters, the Street had been looking for the firm to earn $0.08 per share. Unfortunately, Netflix fell well short of those expectations, with profits coming in at only $0.07 per share.
Needless to say, investors were less than impressed. At the beginning of the trading session on Thursday, NFLX stock plunged more than 7.2% to $102.50 per share. More than $5.0 billion in market capitalization was wiped out.
Do Rosy Estimates for Netflix, Inc. Stand Up to Scrutiny?
How does a company growing revenues at a 20%+ annual clip receive such a bad reaction from the market? Beginner investors are learning a lesson in expectations.
Heading into the quarter, NFLX stock was trading at a jaw-dropping 250 times its earnings. By 1990s technology bubble standards, that’s enough to induce a nosebleed. Even if the company were able to deliver a solid quarter, it would be tough to match the market’s lofty expectations.
And it gets worse. Beyond the disappointing profit number, there was a number of troubling problems if you dig deeper into the quarter. On the user side, Netflix added 880,000 members in the U.S., less than the 980,000 domestic users the company added last year and well short of Wall Street’s expectations for 1.25 million additions.
“While global growth was as we expected, our forecast was high for the US and low for international,” Chief Executive Reed Hastings wrote in a press release. “Our over-forecast in the US for Q3 was due to slightly higher-than-expected involuntary churn (inability to collect), which we believe was driven in part by the ongoing transition to chip-based credit and debit cards.” (Source: “Q3 15 Letter to Shareholders,” Netflix Investor Relations, October 15, 2015.)
But more trouble looms on the horizon…
Netflix has moved to boost overall revenue by increasing the price of its baseline subscription by one dollar per month for new users. (Source: “Netflix raises price of most popular plan by $1 per month,” Bloomberg, October 7, 2015.) This will raise the company’s bottom-line, but might be dangerous in that Netflix could lose subscription growth over this. The most price-sensitive customers may be more inclined now to consider the above-mentioned competitors instead of Netflix. The company has also announced plans to raise the subscription price for existing customers next year, further raising this risk.
If user growth stagnates or even slows substantially, Netflix’s entire success model will collapse, bringing down the NFLX stock price.
More concerning still, Netflix is facing soaring competition from all angles, many of which you might not even be aware. While the company is the clear industry leader for streaming online video, it’s not just names such as Apple, Hulu, HBO, and Amazon.com that it is competing against. The company has stated that it competes with PPV, linear video, online downloading, and other Internet-based video networks in the battle for subscriptions.
Here’s the Bottom Line on Netflix Stock
The hard reality is that Netflix is currently overvalued and it’s no understatement to say that NFLX shares are now essentially riding a bubble. The stock’s forward price-to-earnings ratio is around 325. Even if Reed Hastings and the gang at Netflix can deliver, it might not be enough to save the stock.