Netflix (NFLX) is in the news for negative reasons. The stock has been taking a hit as the market is worried about increased competition from Disney (DIS) and others. Also, there was the news back in July concerning a subscriber-count miss.
Here is a chart plotting the price action (at the time of this writing):
The shares seem on their way to retesting the lows from January. Some have observed that, from a technical standpoint, they may even go below that point. Right now, the 52-week high is $386 vs. $231 for the low. With all of this negative sentiment, one wonders if Netflix’s time is up as far as growth goes.
I don’t believe that is the case. Netflix still has a good future ahead of it. The most recent quarterly reported stated the global subscriber count to be 151 million. That base is a valuable asset. A company can do things with that base. I wonder if the market is now essentially telling management that the subscriber count in and of itself should not be the only thing in which capital is invested. It is time to branch out and explore other opportunities that use the brand equity the company has built for itself. Here are some key things the company could (and should) do:
- Start a theatrical-release strategy complete with a traditional window
- Start a theatrical release strategy with a day-and-date and/or near day-and-date window
- Start cutting content costs and yield more hours per content spend
- Consider Disney’s lower-volume strategy (granted, this might be a riskier bet)
I’ve written in the past about these issues, but as time goes on, they become more relevant, so they are worth repeating. Not only that, but arguably, the current environment as defined by a Disney entry into the arena dictates a quicker adaptation on the part of the management team.
A Multiplex Approach
One of the bigger product releases this fall is The Irishman, from Martin Scorsese and Robert De Niro. The company ran into resistance from theaters looking for a better window to separate the multiplex marketplace from the streaming-war marketplace. Indeed, theater owners didn’t want to be sacrificed in an over-the-top manner in the next skirmish between Netflix and Disney and all the rest. The talent behind that movie, of course, wanted the glamour of a usual, significant theatrical component.
Netflix needs to embrace a windowing strategy to launch a tentpole/small-budget ($100 million+ for the large end of the range, between $5 million and $25 million for the small end) strategy. The company is in a good position to do so for two reasons: it has a great marketing device – the service itself – and it has a lot of data on the four quadrants that subscribe to its service, allowing concept development and probability of success to be metered accordingly. Add that to the value of the brand equity that the company’s name brings to the table and you’ve got a business plan. A multiplex-window strategy will bring in new revenue streams and help Netflix to evolve.
My other bullet point about day-and-date and near day-and-date can be used in complementary fashion. Hybrid releases are common enough (i.e., in theaters and on digital pay-per-view either simultaneously or close to it), but Netflix would have a chance of making higher-profile projects that would be more marketable and would benefit both subscribers and non-subscribers alike (as it is now, hybrid releases oftentimes don’t make too much of a bang in the marketplace; they are utilized as an optimization technique in distribution channels for lower-profile projects). The non-subscriber benefit is in terms of reaching those who have thus far resisted the streaming siren call. That group’s money is just as good as the amounts coming from subscribers.
Cutting Content Costs
This is a tough one, but I have always believed it can be done and I think Netflix CEO Reed Hastings and Chief Content Officer Ted Sarandos should take a look at the stock price and figure it out.
Yes, the first instinct after looking at that price action and gauging current sentiment in qualitative metrics (i.e., what pundits are saying about the company) is to ramp up spending. I get that, I sincerely do; however, there has to be a middle ground in the upper tranches of spending that Netflix could strive for in order to reduce overall cash utilization.
Whatever levers the company can pull as it wheels and deals its way toward this series and that feature would be welcome by shareholders. Overall deals are becoming more expensive every single day in Hollywood, and every next big talent feels entitled to that next big check. Records are made to be broken, after all, and unless Hastings’s plan is to sell out to some trillion-dollar tech company of the near future before all of the profligate talent spending hits an egregious critical mass, he should act now. I’d like to believe he is contemplating this on whatever Bill Gates-like think-weeks he takes for himself and would count that as one reason for shareholders to remain patient (and yes, I could be proved wrong tomorrow if a megadeal suddenly hits the Hollywood press-release circuit). Also of note is the concept of multiple overall deals: if producers start seeking non-exclusivity for their talents, then a company like Netflix could end up overpaying on certain transactions.
I predict that we’ll see some news flow in the coming months concerning Netflix and others making attempts to put the brakes on some of this deal scale. Disney recently indicated it was examining the idea of limiting profit participation (I wrote a piece discussing it).
Low Volume/High Quality?
Disney has said that its D+ product will not attempt a high-volume content approach. It wants to be more selective about its storytelling. This has worked for Disney at the multiplex.
While I’m not certain D+ will always be low-volume (and I suppose Hulu allows Disney to expose itself to a high-volume strategy whenever it wants), I can say that Netflix may want to at least study the idea of perhaps being more selective.
One naturally assumes that the biggest drivers of Netflix’s success tend to be concentrated in a specific, smaller volume of content…as an example, there are probably many subscribers who simply keep paying up for the company’s service for less than a dozen series. This is where the data set again comes into play: if the company can get better at identifying the minimum amount of hours needed to keep subscribers happy and to keep the base growing, then value will start to come into view in the form of a better cash-flow situation.
Disney CEO Bob Iger said a very interesting thing in a recent interview:
“What Netflix is doing is making content to support a platform. We’re making content to tell great stories. It’s very different.”
It is very different, isn’t it? Quite a profound assessment. Again, Hulu has a fair quantity of not-so-good content, as does Netflix, so there is value in investing in not-so-good content. But if Netflix reduced its investment in content for a few years and tried to use its data to focus on just the particular spectrum of hours that people watch, it would possibly represent the fabled future lever that Hastings is expected to pull, the one that will bring in the positive cash flow to go along with the positive income statements. It’s something to consider, and I will concede this is the riskiest idea in my essay. Subscribers are used to the vast choice that Netflix offers, and considering recent price increases, I’m not sure how inelastic the response would be in the marketplace.
Netflix’s second-quarter report tells a familiar tale: positive EPS, negative free cash flow. For the first two quarters of fiscal 2019, the company has used over $900 million for operations and has generated negative free cash of over one billion dollars. Content is king for Netflix at the moment, cash a very ignored pauper.
That’s fair enough to some extent, as management has clearly articulated its strategy over the years. I am bullish on the stock as a long-term investment (and here I must note: I don’t currently own shares as I have managed my portfolio in recent months to focus on certain equities, but I am looking to get back in soon, even if it means I’ll be in at higher prices) because I believe it is only a matter of time before the company begins to expand its horizons and move into different strategies such as theatrical…the market will most likely reward such thinking, and it will help the company move into a better financial/valuation position (right now, the SA quote system does not highly regard the valuation of Netflix shares…at all, as one can obviously imagine; growth and profitability are high, though).
Netflix is ingrained in the pop culture, and it’s not about to disappear overnight. The competitive environment is bound to imply some difficulties, but the company can use its subscriber base to hopefully scale out of them. At the very least, this situation is worth a watch-list placement.
Disclosure: I am/we are long DIS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.