By Patrick Foot, financial markets writer at IG
Like so many traders, markets and central banks, Netflix didn’t have a great time last week.
First, the company’s share price plummeted 25% off of the back of its latest earnings call (see chart below, from IG’s spread betting index), despite reported increases in revenues and profits. Then, over the weekend HBO announced its plans to launch its own standalone online streaming service, HBO Go, in a move that will create a rival to Netflix with a staggering line-up of existing and planned content. Around the same time, CBS announced its own streaming service, CBS All Access.
Netflix’s bad week, as illustrated in its share price October 13-17.
None of this is entirely new. Netflix has always seen a lot of volatility in its share listing, which has swung from above $450 to below $300, then back to $480 in 2014 alone. It also dropped more than 75% in the last half of 2011, before recovering to a much stronger position. HBO and CBS are just the latest in a long line of competent competitors, with both Amazon and Hulu growing in stature for a while now.
It all boils down, then, to a fairly simple to understand (though it certainly isn’t simple to solve) problem for Netflix. The business has long been aware that bigger players will wake up to the success Netflix has been having and that, in a content-led sector, the only way it can continue to lead is by combining its excellent interface with quality shows and films.
The company has illustrated its ability to provide the latter with successes such as House of Cards and Orange is the New Black, whilst deals with Adam Sandler (to produce four movies) and the Weinstein Company (for the impending Crouching Tiger, Hidden Dragon sequel) will test its film-producing acumen.
To produce content requires huge investment, with the technology, talent and marketing needed for a hit show or film needing resource on a level previously never seen by Netflix. And that’s not all, as Netflix may have a fight with major cinema chains on its hands over its intention to stream the Crouching Tiger sequel on day of release. Taking on cinema chains, maintaining its leading position in online streaming, and producing quality content will take cash as well as nous.
The problem, then, is how best to generate the revenue needed for such a challenge. Two options immediately present themselves: one that Netflix has chosen to its possible detriment, and one that it has publically vetoed multiple times.
Netflix’s major failing over the past few months was plain to the markets when earnings were released; new subscriber growth faltered, falling under forecasts by about 600,000. U.S. performance was particularly poor and about 500,000 fewer new subscribers were added last quarter compared to the previous year. The fall off was attributed to a small price increase by Netflix – an increase driven by the need to generate funds.
How much the growth of major rivals has contributed to Netflix’s slowing is unclear. The company’s disastrous end to 2011 was caused by an attempted price rise, though, as Netflix CEO Reed Hastings engaged in a practical business move that proved unpopular with customers. Now, history appears to be repeating itself – and as competition increases, the chance that subscribers remain loyal drops.
The other option for generating revenue is through an entirely new stream: advertising. Netflix’s huge amount of data on its customers – plus its clear ability to ensure eyeballs on ads, and the interactive element added by online advertising – makes for a powerful advertising platform.
So far, Hastings has been vehemently opposed to allowing advertising, arguing that it would be detrimental to consumer confidence and undermine Netflix’s credibility. He probably has a point; but with price hikes proving damaging, it appears that Netflix has diminutive pricing power. The company may have to consider which is the lesser of the two evils.
Or there is a third way. Mark Cuban’s tweet about Netflix last week led to a swathe of speculation about a possible takeover. His sentiment – that the company’s current low price makes it hugely enticing for a takeover – does make sense, even with the possibility that he was just trying to garner a positive move in its stock.
A bigger company with more cash to spend could ensure that Netflix’s content keeps it ahead of the pack without resorting to the possibly disastrous price hike or advertising plans. Just because something makes sense doesn’t mean it’s inevitable, however, and whether those at Netflix would be open to a takeover of any kind remains unknown.
The value of Netflix to another company also remains unknown. While it is hugely valuable, much of that value depends on rapid growth continuing as more and more alternatives attempt to take a chunk of the market. Netflix believes that they have the means to ensure they stay ahead; others may be less confident.
Hastings and Netflix have recovered from worse setbacks than what occurred last week. Competition is growing, though, and now more than ever, Netflix needs to prove that it has the power to not just disrupt an industry – but to lead it as well.
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