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The Spell Is Broken: Netflix Is More Like A Traditional TV Network

Summary

We've long held the belief that Netflix is nothing more than a content delivery platform, one of many to be exact.

Recent developments indicate that Netflix is becoming more like a traditional TV network.

In the midst of this shift, the stock continues to be wrongly valued as a tech stock, which creates significant downside risk.

Shares of Netflix (NASDAQ:NFLX) plunged 12% after-hours on Monday after its earnings report revealed weaker than expected subscriber growth. Most notably, domestic subscriber growth continued to slow.

More shockingly, at 2.5 million the company's projections for its second quarter net subscribers additions are far below expectations (4 million). We think this news should break the spell that has kept investors blind of the poor economics and competitive position of Netflix.

This stock remains highly overvalued. Even if valued at a premium to its much more profitable traditional media peers, the best investors can hope for the stock is $58/share. We think $30/share is the more likely eventuality.

The Spell Is Broken: Raising Prices Hurts Customer Growth

It is a simple law of business that any discretionary product appeals to fewer consumers when it becomes more expensive. How many customers do you think McDonalds (NYSE:MCD) would lose if it raised prices by 11% across the board? It would be a lot, and Netflix is no different.

In our original Danger Zone call on Netflix in November of 2013, we predicted that Netflix would have to raise prices in order to have any hope of generating cash flow and that raising prices would undermine customer growth. Our November 2013 report provides historical precedence for how price hikes affect the company's customer growth: Netflix "shed almost 1 million subscribers in 2011 when it announced a new $16 price for streaming and DVD rental services, up from the previous amount of $10. Customers in this space have many choices, and they will quickly and easily flock to a lower price option whenever needed."

Investors should not be surprised that Netflix lowered guidance for subscriber growth for Q2 after announcing that many long-time users will face price increases starting in May. Netflix raised the price for new subscribers from $7.99 to $9.99/month two years ago, and now long-time users are being "un-grandfathered" and will have to pay the new, higher rate. These users have many more options for streaming video than they did in 2011.

The Spell Is Broken: Netflix Cannot Afford To Produce Original Content And Keep A Big Content Library

For years, Netflix had one significant advantage over its streaming competitors: its massive library of movies and TV shows. As Netflix has pushed more and more into original content recently, it can no longer afford that massive catalog of licensed content. Over the past two and a half years, its content library has shrunk by 32%.

Figure 1: Content Obligations Growing Slower Than Revenue

Sources: New Constructs, LLC and company filings.

Figure 1 shows a data series we've graphed in multiple previous articles on Netflix. Before we discussed the massive increase in the company's...


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