What is the bear case against Netflix’s stock as of early 2018? originally appeared on Quora, the place to gain and share knowledge, empowering people to learn from others and better understand the world. You can follow Quora on Twitter, Facebook, and Google Plus.
With a price:earnings (P/E) ratio of ~210,Netflix is a “growth stock.” The vast majority of its valuation is predicated on expectations of continued high revenue growth and, eventually, future profit. As such, the primary bear case for Netflix is that the company either 1. fails to meet expectations of growth, or 2. fails to meet expectations of profit.
On the growth side, there are various arguments to consider. For this answer I will focus on the long-term threats, but there are important short-term threats too. For example:
Will there be an economic recession in the imminent future? Is Netflix a luxury good? How might a recession affect Netflix versus, say, Amazon? Is Netflix well-positioned to overcome foreign competitors? Is Netflix close to saturating its primary market (i.e. the US), and does it have a plan for continued expansion after this occurs?
Long term, the primary concerns are whether 1. video streaming will be “the future,” and, if so, 2. whether Netlfix will dominate that future.
Citing possible regulation, needed infrastructure, copyright complexities, and the promise of non-passive content like gaming and VR, a bear might argue that video streaming is overhyped. However, the ubiquity of TV, cinema, YouTube, SnapChat, etc. suggests streaming video content will — for at least the next ten years — be a large and growing form of global entertainment.
The next issue is then whether Netflix will profitably dominate this space in the long-term. Here, the bear arguments are stronger.
I. Long-Term Competition from Amazon
As I wrote last April, the world’s largest streaming services, e.g. Netflix, Amazon, etc., appear intent on acquiring and producing a practically limitless amount of engaging, diverse entertainment.
Users, unable to exhaust either sites’ endless offerings, will receive essentially no benefit from purchasing more than one subscription and will thus choose to pay for only one provider. When this happens, Amazon will win because unsubscribing from Amazon Prime will be unthinkable (i.e. it will be too useful).
II. Long-Term Competition from Below
Though inexpensive compared to cable, Netflix is a “premium” streaming product. It only offers high quality, professionally-produced content curated by an experienced team. In many ways, this approach to content acquisition is similar to Yahoo’s manual approach to web search in the late 1990s — it worked well initially, but became untenable as the Internet scaled.
Following this analogy, democratic content-creation platforms like YouTube, Facebook, and Snapchat are well poised to eventually dominate the global streaming market. This argument is more compelling upon consideration of various long-term trends such as the dramatic improvement of content creation tools (e.g. low-cost cameras, drones, software, etc.), the revolution in machine learning to better sort, recommend, and understand content, and more diverse tastes demanding more diverse entertainment.
III. Continued Growth is Dependent on Globalization
More than any of its high-quality streaming competitors, Netflix is an internationally-focused company. With already high domestic penetration, the vast majority of Netflix’s future growth is expected to be outside the US. As such, a bet on Netflix is akin to a bet on globalization. If you believe the world will continue to come together, converge toward one culture, watch the same content, interact with the same user interfaces, etc., then you should be optimistic about Netflix’s future prospects.
Conversely, if you believe the world is rejecting globalization —that the rise of nationalism and the sluggishness of economic growth portend less cooperation and more aggression or isolation— then you should be skeptical of Netflix’s growth estimates, and therefore price.
IV. Narrow Moat and Poor Vertical Positioning
Sustained profit is only achieved by firms that build “moats” around their business; otherwise, competitors will enter, driving down prices and reducing net incomes to zero. Traditional television providers (e.g. DirecTV, AT&T U-verse, Dish) are highly profitable because they have built steep barriers to entry through regulation and capital-intensive investments.
Though Netflix’s subscription model requires spending a lot of money to acquire premium content, video streaming is not an inherently difficult or expensive space to enter, e.g. there are millions of online porn sites. Over time, other models such as ads (YouTube), a la carte (iTunes), or hybrid may prove superior, and far less profitable.
Furthermore, with the repeal of net neutrality, it is possible that most of the value from video streaming eventually shifts to players lower in the supply chain, i.e. to Internet service providers (ISPs) or cloud services platforms. Without a moat to guarantee pricing power over its consumers and without legislation to guarantee pricing power over its suppliers, Netflix may never become significantly profitable. This would likely be the worst-case scenario.
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