The future of the streaming industry will be one with multiple companies bidding against each other for exclusive content, leading to ever-rising licensing costs for the streaming services to bear. The companies that control the content are the real winners, not the company’s that stream the content.
Now, that’s not to say that Netflix, Inc. (NFLX) won’t be profitable in the future–but I think expectations have gotten a bit outrageous. In 2011 the stock plummeted from $300 per share to around $60 per share, and was trading near $50 per share late last year. Since then the price has rocketed up to $185. This price is 44.5 times earnings from 2011 and 638 times earnings from 2012. What really matters though, are future earnings. And the market seems very optimistic about the future.
Predicting earnings for a company like Netflix is very difficult. As the company adds more subscribers the cost to license content will rise, as any content-controlling company will raise the cost on renewal to account for the larger subscriber base. You also have competitors bidding up that price, making the situation even worse for Netflix. In the short term margins will probably improve as the international segment becomes profitable, but content costs are a big problem in the long term.
In response to this Netflix, Inc. (NFLX) has begun creating its own content, spending $100 million to develop the well-reviewed drama “House of Cards” and bringing back cult favorite “Arrested Development” for one more season. In order for this strategy to work Netflix needs enough regular, high quality content for people to subscribe solely for that content. The costs are high, and the payoff is uncertain.
When the stock was trading for $50 per share I think a reasonable argument could have been made for it. But at $185 per share no such argument exists. The fact that the company provides a popular service isn’t enough considering the massive content-related liabilities going forward. If Netflix were to become extremely profitable, what’s stopping the content providers from demanding a bigger price upon renewal of their contracts, thus pushing profits back down? Netflix has no leverage here.
The bottom line
I don’t think that Netflix is doomed, but the market’s expectations are borderline insane. We’ve seen this show before – when Netflix hit its peak in 2011 it traded at around 70 times the earnings of that year. There’s another peak coming, and I don’t want anything to do with it.
The article Outrageous Expectations: The Netflix Story originally appeared on Fool.com and is written by Timothy Green.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.
