UPDATE: Netflix's stock is worth only about one-third of where it trades today
6:01 pm ET June 18, 2017 (MarketWatch)
By David Trainer and Kyle Guske II
The math shows why the Netflix business model is unsustainable
In the past three weeks, Netflix has cancelled two of its original series (http://www.marketwatch.com/story/netflix-has-to-cancel-shows-because-not-even-it-can-keep-spending-like-this-2017-06-12) ("Sense8" and "The Get Down"
after canceling only five series from 2013-2017. These cancellations come on the heels of executives' comments about needing a better return on investment.
When taken together, it's clear Netflix(NFLX) is beginning to acknowledge the challenging economics of producing original content, just as we warned in April 2016 (https://www.newconstructs.com/spell-broken-netflix-like-traditional-tv-network/). Creating successful original content is very costly and very hit-or-miss. The surfacing of this ugly truth could be a catalyst for more investors to question the viability of Netflix's business model and to send its shares to a more rational level, which is close to $50 according to our reverse discounted cash flow modeling scenarios and about one-third the level of where they trade today.
Content costs continue to outpace revenue growth
Apart from the two cancellations, Netflix's streaming content obligations continue to grow faster than revenue. We first warned (https://www.newconstructs.com/netflix-nflx-even-dangerous/) about Netflix's alarming streaming-content obligation growth in 2014. Since then, the issue has only worsened as free cash flow has fallen further.
Since 2010, content obligations have grown 42% compounded annually while revenue has grown 24% compounded annually, per Figure 1. At the end of the first quarter of 2017, content obligations totaled $15.3 billion and have grown faster than revenue year over year in six of the past seven years. Netflix Chief Content Officer Ted Sarandos recognized this issue when he stated "a big expensive show for a tiny audience is hard, even in our model, to make that work very long."
Cash burn compounds obligation growth issues
As Netflix's content obligations increase, its free cash flow (FCF (https://www.newconstructs.com/education-free-cash-flow/)) only grows more negative. Since 2010, the last year Netflix generated positive FCF (and first year it began increasing its content library), Netflix has burned through a cumulative $6.4 billion in cash, per Figure 2.
Membership growth can't offset costly content
Netflix could certainly justify the massive content costs were it rapidly expanding its membership base. One could argue that membership growth (and subsequent revenue) more than offsets the costs of creating original content. However, Netflix's membership growth rates, both domestically and abroad, have been slowing for quite some time.
Per Figure 3, international members grew 39% year over year in the first quarter of 2017, down from 65% in the first quarter of 2016 and 78% in the first quarter of 2014. Similarly, domestic members grew 8% year over year in the first quarter of 2017, down from 13% in the first quarter of 2016 and 22% in the first quarter of 2014.
NFLX has really taken a DUMP.
WHY?
6:01 pm ET June 18, 2017 (MarketWatch)
By David Trainer and Kyle Guske II
The math shows why the Netflix business model is unsustainable
In the past three weeks, Netflix has cancelled two of its original series (http://www.marketwatch.com/story/netflix-has-to-cancel-shows-because-not-even-it-can-keep-spending-like-this-2017-06-12) ("Sense8" and "The Get Down"
after canceling only five series from 2013-2017. These cancellations come on the heels of executives' comments about needing a better return on investment. When taken together, it's clear Netflix(NFLX) is beginning to acknowledge the challenging economics of producing original content, just as we warned in April 2016 (https://www.newconstructs.com/spell-broken-netflix-like-traditional-tv-network/). Creating successful original content is very costly and very hit-or-miss. The surfacing of this ugly truth could be a catalyst for more investors to question the viability of Netflix's business model and to send its shares to a more rational level, which is close to $50 according to our reverse discounted cash flow modeling scenarios and about one-third the level of where they trade today.
Content costs continue to outpace revenue growth
Apart from the two cancellations, Netflix's streaming content obligations continue to grow faster than revenue. We first warned (https://www.newconstructs.com/netflix-nflx-even-dangerous/) about Netflix's alarming streaming-content obligation growth in 2014. Since then, the issue has only worsened as free cash flow has fallen further.
Since 2010, content obligations have grown 42% compounded annually while revenue has grown 24% compounded annually, per Figure 1. At the end of the first quarter of 2017, content obligations totaled $15.3 billion and have grown faster than revenue year over year in six of the past seven years. Netflix Chief Content Officer Ted Sarandos recognized this issue when he stated "a big expensive show for a tiny audience is hard, even in our model, to make that work very long."
Cash burn compounds obligation growth issues
As Netflix's content obligations increase, its free cash flow (FCF (https://www.newconstructs.com/education-free-cash-flow/)) only grows more negative. Since 2010, the last year Netflix generated positive FCF (and first year it began increasing its content library), Netflix has burned through a cumulative $6.4 billion in cash, per Figure 2.
Membership growth can't offset costly content
Netflix could certainly justify the massive content costs were it rapidly expanding its membership base. One could argue that membership growth (and subsequent revenue) more than offsets the costs of creating original content. However, Netflix's membership growth rates, both domestically and abroad, have been slowing for quite some time.
Per Figure 3, international members grew 39% year over year in the first quarter of 2017, down from 65% in the first quarter of 2016 and 78% in the first quarter of 2014. Similarly, domestic members grew 8% year over year in the first quarter of 2017, down from 13% in the first quarter of 2016 and 22% in the first quarter of 2014.
NFLX has really taken a DUMP.
WHY?
