Netflix – An opportunity with a lot of risk

Netflix’s share price declined by over 60% since its highs in 2021, which offers a cheaper entry point but comes with a lot of risks.

Netflix was founded in 1997 by Reed Hastings and Marc Randolph, who launched a DVD subscription service in 1999.

Subscribers who paid a fixed monthly fee could receive as many movies as they wanted. The movies were mailed to customers as DVDs together with a prepaid return envelope.

Netflix also offered DVD sales but discontinued it as it could not compete against large retailers like Walmart.

The move paid off as the company’s revenue increased substantially from 2000 to 2006.

At the time, Netflix faced fierce competition from movie rental companies like Blockbusters which had the same business strategy of DVD-by-mail.

It realised the future of movies was not DVDs but Internet streaming. In 2007, following a big data centre investment, Netflix introduced movie streaming with its “watch now” feature.

Because of its early move to streaming, Netflix struck favourable deals with media producers and studios as they were still unfamiliar with streaming licenses.

It was a crucial shift in the business and fundamental to its success. Netflix also started launching “Netflix original” shows and expanded its library.

The company showed exceptional growth, and its share price increased from its IPO price of $1.20 in 2002 to a peak of $691.70 in 2021.

Last year, Netflix started to face headwinds which showed in its disappointing Q1 2022 subscriber growth.

The company forecasted that it would increase its subscriber base by 2.5 million. It was much lower than the previous quarter’s 8.3 million subscribers.

Netflix also announced revenue and operating margin forecasts that were much lower than for the 2021 Q1 period. 

It forecasted a 10.3% increase in revenue compared to the previous year’s 24.2% increase and an operating margin of 22.3% compared to the previous period’s 27.4%.

Investors responded negatively to this news – the share price fell 22% following the announcement.

The bad news was not over.

In its Q1 2022 earnings release, Netflix announced that it had lost 200,000 subscribers. It was in stark contrast to its growth forecast of 2.5 million subscribers.

It was the first time in over a decade that the company had a net subscriber loss.

The company warned of a further 2 million subscriber loss for the second quarter, which spooked many investors.

The share price fell by 35% on the day of the announcement as investors feared the streaming giant had reached the end of its growth stage.

Another risk for Netflix

A large part of Netflix’s library is licensed content from other producers. Netflix pays a license fee to host these shows on its platform.

Many content producers, including Disney, have launched their streaming services.

The risk to Netflix is that these new streaming services will pull their licensed content from Netflix to host it exclusively on their new platforms.

At the beginning of 2022, Disney announced that it would remove many of its shows from Netflix. It is at risk of losing more Disney content in future.

According to CNBC, most of the 2021 top 10 watched shows on Netflix were licensed content, including the top watched show, Criminal Minds.

As seen below, Netflix’s licensed content has decreased since 2019 and will most likely decrease further.

To address this challenge, Netflix is investing heavily in its own shows and movies.

The chart below shows how Netflix’s produced content has increased relative to its licensed content since 2016.

It is unclear what portion of Netflix’s revenue is generated by both licensed and produced content.

However, Netflix is facing a challenging period as 45% of its operating assets are still licensed content.

If these assets are removed from the platform, it may severely impact the streaming giant’s future revenues and subscriber base.