Finally, international subs jumped 229%, but the company still lost money on this segment! Not only did Netflix lose $105 million overseas in the fourth-quarter, but that figure was 75% higher than in the year-ago period. Furthermore, international streaming losses are expected to continue for the immediate future, with only “modest sequential improvements” moving forward.
Weighing these two sides, I can’t help seeing big yellow flags from a valuation standpoint, given all of these potential negatives. With the stock at 13 times book value and a ludicrous 66 times forward sales, I believe investors are discounting the impact of future competition and negating Netflix’s inability to generate cash from operations given the rising cost of acquiring content. In short, sign me up for a CAPScall of underperform.
Alex’s take
We should have done this a year ago. I still remember watching Netflix peak and then crater during my first few months as a Foolish writer. It seemed like an overreaction then, and I could have mustered plenty of arguments in support of an outperform call for early February 2012. Its subscriber base was still growing rapidly — more than 6.2 million subscribers joined Netflix in 2011, despite the price increases that will live in infamy. Netflix’s net margin was also roughly in line with its past two years, and its P/E was near its lowest levels ever after peaking near 80 at the stock’s 2011 heights . It seemed reasonable to expect a rebound from that point onward.
However, we’re not talking about 2012. We’re late to what’s undoubtedly been a wicked party for Netflix shareholders. The problem with wicked parties is that staying too long will leave you with a wicked hangover. No matter how hard we party with you happy shareholders right now, there’s no way that we’re going to capture similar gains out of a stock that’s gone up 80% in less than three weeks. We’ll just wind up with a hangover and no great memories to show for it.
Sean already pointed out valuation concerns, but I’d like to further highlight the rising costs of Netflix’s streaming business from year to year, as discussed in its annual reports:
- In 2008, content acquisition expenses increased by $24.0 million.
- In 2009, that expense increased by another $46.6 million.
- In 2010, content acquisition and licensing spending jumped another $267.8 million.
- In 2011, that expense shot up another $674.4 million.
- In 2012, content and licensing costs were up another $397.7 million.
In five years, Netflix’s gross margin has declined from 33.3% to 27.3% while operating expenses as a percent of revenue have grown 1.5%. That’s not a good trajectory. It’s possible that this will reverse as Netflix locks in more agreeable licensing deals, but that’s not going to happen in the near future. If Amazon is serious about mastering this market (and Amazon is serious about mastering everything, apparently), the competition will only encourage content providers to jack up their licensing fees.
Producing costly series like House of Cards helps differentiate Netflix, but putting that series together cost $100 million, and it would be silly to think that subscribers are going to be happy with just a few new shows per year. A Forbes feature on Time Warner Inc. (NYSE:TWX)‘s HBO, which Netflix CEO Reed Hastings clearly sees as a mortal enemy, cites a figure of $75,000 per minute in production costs for a high-quality scripted drama like the blockbuster Game of Thrones. That lines up with House of Cards‘ cost for two seasons. A five-series lineup will cost Netflix about $250 million a year. In the long run, that’s a good investment when annual revenue is approaching $4 billion, but not if it eats into already-dwindling margins.
