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Netflix Is In Trouble

Summary

Netflix faces increasing competition for content and subscribers.

Recent price hikes indicate the business is approaching maturity in the US.

Valuation at current levels assumes continuous strength in the US and rapid growth overseas with increasing profit margins, despite a more challenging environment.

Netflix's (NASDAQ:NFLX) apparent success has attracted competition from tech giants and similar OTT (over the top) platforms. Subscriber growth has stagnated, and content has become more expensive to license and produce. Netflix's pioneering service has made content cheaper and more convenient for users. However, the structure of the home entertainment industry remains the same: content owners license their property to intermediaries that deliver it to viewers. Netflix's technology and content delivery platform is now being readily copied, putting Netflix in a weaker position relative to content creators. Netflix is no longer unique and it is hard to justify its current valuation in its current form.

Competition for content

Netflix has announced it is going to spend $6bn in 2016 alone to beef up its content, split between producing and licensing shows and movies. Company data supporting that hours of viewership in 2015 increased in absolute terms is misleading. When adjusting for subscriber growth and investment in content, which were increased significantly, viewership per subscriber for a given number of shows actually fell in 2015, a proof that the company's return on investment in content is not paying off. The reasons for that are multifold.

Further, we had just finished watching season three of NFLX's leading original content show, House of Cards, which appeared to be scripted to compete with Ambien.

David Einhorn, Q2 2015 Letter to Investors

First, each Netflix original has not been and is not expected to be a slam dunk. While viewership shortfalls do not directly create additional costs, they will mandate additional production spending. Creating more originals in order to keep up with subscriber preferences would be a significant challenge to the company's content development and financing plan. It is worth noting that out of the 20 original series Netflix has aired as of 2015 year end, only one has exceeded the 20% viewership threshold (all episodes) and only seven more have managed to allure 10% of the viewers (chart below).

Source: UBS Evidence Lab, Nov '15 survey

While Netflix has been investing meaningful amounts to expand its originals library, it seems unable to impress its viewers by launching series with higher viewership than Orange Is the New Black and House of Cards, shows it launched in 2013 and which are now in their third and fourth seasons respectively.

Second, Netflix's main viewership strategy of limited, free content that relies on viewers binge-watching is not a sustainable growth strategy. Although it appears successful in the case of a handful of hit series, these cannot last for more than another 3-4 years, putting pressure on the company to create the next blockbuster. In addition, by giving the subscribers the option to select their watching windows, the company risks losing those that pay-per-month only to watch a specific season. In contrast, Amazon is on a stride to allure viewers through a broad offering of...


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