Netflix (NASDAQ:NFLX) stock has fallen as forces from both within and outside of the company weigh on the equity. The streaming giant has long benefited from a strategic vision that created and bolstered its industry. This has led to gains for NFLX stock of nearly 300 fold since its 2002 IPO.
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However, this industry has now become more crowded. Netflix, once on the cutting edge of the streaming content industry, now struggles to remain relevant in the business that it created. Between the rising burden of content costs and the overall stock market pointing to a possible recession, Netflix stock appears poised to keep falling.
The Long Honeymoon for NFLX Stock Has Ended
In a recent article on Netflix stock before it reported earnings, I urged investors to turn cautious due to the company’s increased competition. Soon after, a disappointing report took NFLX down by about 10.3% in the following trading session.
Its last earnings release saw it fall, but not because of earnings. Profits actually exceeded Wall Street estimates. It lost value due to the slowing rate of subscriber growth. The company reported 2.7 million added subscriptions when Wall Street had predicted an increase of 5 million.
Subscriber growth will likely continue to suffer. With Disney (NYSE:DIS) starting its own streaming service, many of the site’s popular programs transition from company asset to competition. Moreover, Netflix stock faces a growing threat from peers such as Amazon’s (NASDAQ:AMZN) Prime Video, a new offering from Apple (NASDAQ:AAPL), AT&T’s (NYSE:T) WarnerMedia and the streaming service from Comcast (NASDAQ:CMCSA).
For years, Netflix stock commanded a premium valuation because it dominated the streaming industry it created. This decimated not only the video rental industry but also pay-TV. Now that the pay-TV outlets have established their own streaming platforms, Netflix’s long honeymoon looks set to end.
How much further this will bring Netflix stock down remains unclear. From a growth standpoint, this is not a case of a stock going from good to bad, but merely from great to very good. The forward price-to-earnings ratio has fallen to around 52. Profit estimates fell after the latest earnings report. Still, Wall Street forecasts 22% earnings growth this year and 73% next year. I have trouble labeling that valuation as “high” given these profit increases.
Competitors Are Not the Only Threat to NFLX
However, I see multiple compression continuing for other reasons besides the competition. The inverted yield curve that led to a recent market selloff points to a recession. This has served as a reliable indicator for decades. Investors have little tolerance for equities with high multiples in such trading environments.
Furthermore, Netflix stock only remains profitable from a certain point of view. Massive content spending has made a key financial statement more like an “un-balance” sheet. The company spent $10.5 billion on original content over the last year. This is nothing new. However, in the previous year alone, long-term debt rose from $8.34 billion to $12.59 billion.
This poses a tremendous burden on a company with only $6.11 billion in book value. Sadly, despite all of this spending, its original content budget remains smaller than that of Disney, NBCUniversal, and WarnerMedia.
Deep-pocketed companies such as Disney and Apple can maintain this pace more easily than Netflix. Moreover, the falling stock price could lead the company to dilute Netflix stock more quickly to shore up its balance sheet. Given these pressures, I see only reasons to sell at these levels.
Final Thoughts on Netflix Stock
Increasing competition and pressure to spend on content will likely lead to more multiple compression for Netflix stock. The company continues to maintain high levels of revenue and profit growth. However, the company’s rising peers have hurt Netflix in a more fundamental way. Rising debt levels indicate that Netflix may lose its ability to maintain the current pace of content spending. Despite expending $10.5 billion on original content, it lags behind many of its competitors.
Moreover, the elevated stock price could lead investors to forget that Netflix is a $6.11 billion company with a $129 billion market cap. This points to a tremendous incentive to dilute Netflix stock to address the company’s $12.59 billion in long-term debt.
I expect Netflix to maintain a healthy growth rate as a company. However, NFLX stock looks poised to bear the costs of that growth. I recommend getting out now before these costs increase further.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
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