Expectations are sky-high for the streaming company's future growth. But are they too high?
It’s not easy being the king. In Netflix’s case, being the most popular streaming-video service means that expectations for the company are sky-high—and so is the share price. When you trade at those levels, even the tiniest sign of weakness can trigger a wave of fear, which is exactly what happened after the company reported its latest quarterly results on Monday.
When Netflix announced earlier this year that it was expanding into more than 130 countries, the company’s investor fans got excited about the potential growth that this expansion might bring in terms of new subscribers.
Some of that growth has materialized: Netflix NFLX said it added 6.7 million subscribers in its latest quarter, including 4.5 million internationally. That beat analysts’ consensus forecasts. But the company’s projected growth is well below what most had expected. It will likely add just 2 million new international subscribers in the next quarter, when most analysts had estimated it would add 3.45 million. That’s a big miss.
On the Netflix earnings call—which actually took the form of a live interview with CEO Reed Hastings and other senior executives broadcast on YouTube—the company explained that its international growth is somewhat lumpy because of how the roll-out is working in different markets. In some cases, they said, there had been a big uptick because of pent-up demand, but that might not continue in the future.
Watch: Your Netflix subscription just got more expensive
Whatever the explanation, the lackluster forecast stoked the market’s fears that Netflix’s growth rate would start flattening compared to its past performance, fears that pushed the stock down by as much 14% in after-hours trading on Monday (the fact that Amazon just launched what looks like a significant Netflix competitor probably didn’t help).
It’s not as though Netflix will suddenly stop adding new subscribers or growing revenue—it’s more the rate at which those things happen that matters. When your stock trades at almost 100 times your projected earnings for the next year, you are essentially performing a kind of high wire act, and the downside risk is substantial.
Over the past year or so, Netflix has become the poster child for the cord-cutting phenomenon, in which younger video consumers either get rid of their cable box or don’t even sign up for one, preferring to use Netflix and other streaming services like Hulu.
Being the symbol of that movement, and building an impressive portfolio of hit shows like Orange Is The New Black and House of Cards, has helped the company achieve a market capitalization of more than $45 billion—which makes it more valuable than CBS, HBO and Viacom put together. Some of that premium is clearly justified, but how much? That’s what the market is currently trying to figure out.
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One of the risks for Netflix is that its growth will slow simply because it already has more than 80 million subscribers, with about half of those in the United States. In a sense, most of the people in the U.S. who might want Netflix probably already have it.
That—along with increasing competition from Amazon AMZN , as well as HBO—means the company must continue ramping up its offerings of TV shows and movies to appeal to as many new users as possible. And that is going to require a massive investment in content production. This year alone, the company plans to add 10 feature films, 30 kids shows and 12 documentaries, for a total investment of $5 billion.
Some of this focus on original content is also being driven by the TV networks and other media companies that have licensed content to Netflix in the past, at fairly favorable rates. Many of these players are increasingly reluctant to give the company their best programming, in part because they want to roll out their own streaming services.
The end result is that Netflix’s costs are increasing fairly dramatically, and that is having—and will continue to have—an impact on the bottom line. Even in just the past year, Netflix’s operating profit margin has narrowed substantially: A year ago it was 6.2%, and in the most recent quarter it was just 2.2%. Those pressures are part of the reason why the company boosted its prices earlier this year.
There’s no question that Netflix is still sitting comfortably on the streaming-video throne. It’s going to take more than a forecast miss or a new Amazon video offering to topple the company from its perch. But kings have been deposed before, and it’s usually a messy business. That’s what many Netflix shareholders have nightmares about, and that’s not likely to change—if anything, it may get worse.