Netflix and chill....or not?

Paid subscriptions have still increased around 26% since the previous year but this disappointing news calls into question the explosive growth story on which Netflix is priced to perfection (or not). Investors value Netflix at a premium to other media companies because of the potential for future growth. The big question is whether this is a short-term blip or the start of a long term trend. 

There must come a point when subscriptions are saturated, so asking how high can subscriber growth go is prudent. In the US around 60% of broadband households have Netflix, but in other markets like India this is single digits.

Reasons behind the miss in subscription growth include a lack of new content and additional seasons, the World Cup distraction, and increasing competition. Amazon, Hulu, Google and soon Apple are all challenging Netflix in the video streaming space. Walt Disney Company is hoping to boost its pipeline streaming platform through the Fox acquisition. AT&T also have similar plans for Time Warner’s video content. As competition rises this will put further pressure on Netflix's subscription growth rate. Netflix will have a tough year ahead as the content space becomes more competitive and its will have to prove its product reigns supreme. 

It could be too early to call it quits on Netflix as new releases and new seasons scheduled for later this year can return subscriber growth to previous highs along with no World Cup distractions. This coupled with Q4, and northern hemisphere indoor weather, being a seasonally strong quarter for Netflix in past years could calm the nerves. There is also scope within the business model to modify pricing plans as there is arguably a degree of price inelasticity with the platform. 

Valuation has always been the big concern on Netflix and the main angle for hedge funds to short Netflix shares. So far, the short trade has been terrible with Netflix riding the momentum wave to over $400/share up from $50 in early 2015. At this point we would still be wary of shorting the momentum trade. Remember, as Keynes famously said, "financial markets can remain irrational far longer than you can remain solvent". 

With an EV/EBITDA ratio of 123x and with the stock trading at about 170 forward earnings, Netflix is without a doubt the most expensive US large cap technology stock, raising concerns regarding the risk-reward ratio going forward.

As our Head of Equity Strategy, Peter Garnry, notes, on a long enough time horizon, we know that valuation is inversely linked to performance (there are, of course, exceptions to the rule). The reason why investors are willing to pay such a steep premium for the shares is that the fact that Netflix is likely to dominate streaming content for the next decade with no apparent competitor really in a position to threaten that outlook.