U.S. Markets closed

Are Investors Souring on Netflix?

- By John Kinsellagh

Legacy media companies are slowly entering the digital streaming fray. After Walt Disney Co. (DIS) introduced its digital streaming package, which is called Disney+, many investors sounded the alarm bells for Netflix Inc. (NFLX), the streaming pioneer and king of the direct-to-consumer hill.

After Disney announced the particulars for its streaming service last week, Netflix shares were down approximately 5% on Friday, while Disney's stock increased more than 10%.


While Netflix's first-quarter numbers, which were posted on Tuesday, beat consensus estimates, investors soured on the company because its guidance for the second quarter fell far below analysts' unrealistic expectations. The company said second-quarter earnings would be close to 55 cents per share on revenue of $4.93 billion. Analysts anticipated 99 cents a share on a revenue estimate of $4.96 billion. Analysts were looking for 5.96 million new subscribers; Netflix projected 5 million.

656679638.png

Analysts' discomfort was based on the fear Disney would start to eat into Netflix's subscriber base with its array of programming. In short, many investors believe in the erroneous zero-sum scenario that Disney's gain will be Netflix's loss. Two factors, however, militate this overly pessimistic projection.

When Disney announced details for its streaming package, which is set to launch in November, investors seemed quite pleased and the company's shares rose to record highs. Disney+ will be offered for $6.99 a month -- approximately half of Netflix's $14 premium subscription. Exactly what programming do consumers get for their money?

Disney+ will offer subscribers its family-friendly films and series as well as diverse offerings from its own library and productions, such as the popular "Star Wars" franchise and productions from its lucrative Marvel properties. The package will also include selected films from the vast library of recently acquired Fox Studios. In addition, the company said nine original content programs would be available upon the service's November launch date. This is, by any measure, an impressive package.

Even in light of the generous amount of programming offered in the basic Disney+ subscription bundle, Netflix has little to worry about in terms of attrition in its subscriber base.

Another important point to keep in mind is some of Disney's family-friendly productions as well as some of its blockbuster cinema movies were all produced and offered to viewers at a time when Netflix was still a mail-order business, with no plans for delivering original content. Today, however, Netflix has evolved into a respectable original movie producer that has raided a significant amount of Hollywood talent to implement its ambitious production schedule.

Consider the following: A Netflix production, "Roma," was nominated for an Academy Award for best picture -- a scenario that would have induced side-splitting laughter just two years ago. Some of the company's other original content productions grabbed the attention of millions of households. For instance, the thriller "Bird Box" was viewed by over 80 million households. This ability to capture an audience should be reason enough to drop analysts' overly optimistic view of Disney's unrealistic subscriber targets down a notch .

Disney isn't the only game in town now for producing highly successful, popular movies. There is a built captive subscriber base for Disney's existing products. Its profitable and popular franchises, such as "Star Wars" and Marvel superhero tales, will always appeal to this slice of the overall potential streaming market that is up for grabs. The great challenge for Disney will be its ability to grow and expand its loyal viewer base and capture new subscribers. Currently, the company is ill-prepared to meet these goals. One research who concurs with this view is BTIG analyst Richard Greenfield.

In a note, Greenfield addressed a major issue that too many are not factoring into their rosy outlooks for Disney. "As you look back at the history of direct-to-consumer subscriber services, subscriber growth after the initial wave of gross adds is deeply tied to additional original content," Greenfield wrote. And here, Netflix is light years ahead of the competition.

As Sumner Redstone once said, "Content is king." Redstone was right, so it is illuminating to compare Netflix with Disney using the crucial original content metric. Netflix spent almost $12 billion on original content in 2018, and it is planning on spending even more. In a note to clients in January, BMO Capital Markets analyst Daniel Salmon estimated Netflix's annual spending for original content will hit $17.8 billion by 2020.

Compare this budget to Disney's projected spending for original content: The company said during its investor day last week that it is planning to spend $1 billion a year on original content for Disney+, with expenditures to reach the "mid-$2 billion" mark annually by 2024. For Netflix naysayers, it is important to note Disney estimates its streaming service won't become profitable until 2024.

Queasy investors may wish to revisit their Netflix misgivings in light of the factors noted above, which point to a strong future in the near to intermediate term.

Disclosure: I have no positions in any of the securities referenced in this article.

Read more here:



N ot a Premium Member of GuruFocus? Sign up for a free 7-day trial here .

This article first appeared on GuruFocus.