The internet information providers industry is one of the most volatile markets to operate in and Netflix (NFLX, Financial) happens to be one of the main players. The company has enjoyed a solid rally this year, with the stock price increasing from about $48 per share to about $126 per share a few weeks ago, but has in the last few days slumped to trade at $101 per share.
While Netflix's current price represents more than 100% gain since the beginning of the year, it is good to note that investors have been buying into the company’s growth plan, which involves focusing on streaming unique content. However, the recent plunge coincided with the news that the company was not going to renew its contract with cable network company, Epix, which means that Netflix will no longer be able to stream popular movies like The Hunger Games, Transformers: Age of Extinction, and World War Z, among others.
There are many players, but Netflix’s main threat comes from Apple and Amazon
Online streaming services are increasing in number and most of them are cheaply available, while others come free of charge, though loaded with a lot of ads. As such the so called popular movies and television series are already being offered by these services, some legally, while others questionable and this is making the whole point of offering popular programs and movies in platforms like Netflix less admirable to the company.
Additionally, other huge technology companies like Apple (AAPL, Financial) and Amazon.com (AMZN, Financial) are also looking to claim a share of the video streaming market, while the likes of Comcast’s (CMCSA, Financial) NBC Universal, Walt Disney (DIS, Financial) and 21st Century Fox (FOX, Financial) have been there for ages. Hulu, which is co-owned by Disney, Fox and NBC Universal is also in the frame and has been growing massively over the last couple of years.
Hulu’s subscriber base increased 50% through April 2015 to 9 million from 6 million subscribers in April 2014. This may not be significant at the moment given Netflix’s 65+ million subscribers, but it shows just how companies are eager to venture into the streaming market.
However, it is the big giants in the frame of Amazon and Apple, which Netflix should really be worried about, because these already have a huge following/customer base, albeit in other product lines. The online video streaming industry is expected to grow to about $13.7 billion by the year 2020, and this is attracting more players as they look to claim their share of the cake.
In fairness, the online video streaming market is growing at a faster rate than its radio counterpart, but even then, the growth is not as rapid as the number of players. The market is adding roughly $1 billion every year, which means a CAGR of about 10% for the next five years.
Now, when you compare this with the increasing number of subscribers, it is clear that increase in subscription base does not necessarily result in increased revenues, at least not by the same rate.
Currently, Netflix is the dominant player in the online video streaming market. The company’s annual revenues stand at $6.11 billion for the trailing 12-month period, which means that it will account for the majority of the estimated $8.7 billion for the year 2015.
However, there is no guarantee that the company will continue dominating the market in the coming years, especially given the coming launch of a new version of Apple TV next week, which is expected to disrupt the online video streaming market.
There is a great expectation that Apple will be launching a Netflix-style subscription service along with the Apple TV next week, and this means that Netflix should brace itself for a major rivalry in the streaming business.
A couple of years ago, Apple launched its own Pandora (P, Financial)-style internet radio, which automatically sent shockwaves in the internet radio streaming market raising questions over the futures of Pandora and Sirius XM (SIRI, Financial). And while they have managed to wither the initial storm, competition in the market has not been the same since then. Spotify (SPTF, Financial) is facing a similar case following the launch of Apple Music in June this year. The company has vowed to continue improving the service as it seeks to take on the dominant player in the market Spotify.
Apple has a wide customer base through its multiple products. The Apple iTunes for instance, has more than 250 million users, and according to research published in April this year, 20% of the users said that they would be willing to pay $7.99 for a premium services. Therefore, this gives Apple a lot of flexibility in launching a premium online video streaming services as it can expect to convert a large number of its users into premium subscribers.
The same case goes for Amazon, which currently has more than 270 million users, and as of January this year, the company’s prime subscribers were estimated at about 58 million. Again, if the company could manage to get a majority of its subscribers to subscribing to its video streaming service, then Netflix will be facing another major rivalry from another of the largest technology companies in the world.
Investors have been buying Netflix on the promise of growth
Amazon investors have been buying into the company’s growth story for years, and now online video streaming could be the next frontier.
This has also been the case for Netflix as its share price has rallied to match the company’s revenue growth, rather than earnings growth. Illustratively, both Amazon and Netflix are typical of the modern day internet information providers as investors continue to invest based on the promise of growth, rather than earnings growth.
As shown in the chart above, it is quite clear that Netflix has shown significant revenue growth over the last five years, which currently supports the company’s increased market value. However, earnings, just like is the case of Amazon.com have remained flat.
The big challenge for Netflix as compared to Amazon though is the fact that Amazon has multiple streams of income, and is a leading player in online retail. The business of online video streaming serves as compliment to its several other business units and aligns well with its core overall business. As such, the company can expect its various business units to augment each other and in the process boost the video streaming business thereby eating on Netflix’s core business.
Valuation
Netflix currently trades at a P/E of 226x compared to industry average of about 25x. That’s nearly 10x the industry average, which makes it quite an expensive stock to own if buying purely on the basis of valuation. This perhaps shows how much confidence investors have on the company’s growth story.
However, even factoring growth, Netflix is still very expensive trading at 21x in PEG compared to the industry average of about 6x, while its P/S also remains way above industry metrics at 7.35x versus 2.30x.
Perhaps the most positive sign with regard to Netflix when compared to industry average comes in the form of revenue growth for the most recent quarter which stands at 23% year-over-year versus 17% for the industry.
Netflix’s recent stock price decline has made it look somewhat attractive from a technical perspective, but when you look at it fundamentally, not even its massive cash flow can save it from declining further in the coming quarters. If Apple confirms the launch of a Netflix-style streaming service then investors can brace themselves for another dive next week, which could sustain through the rest of the year.
Conclusion
The bottom line is that Netflix has been trending high for the majority of this year, but it has experienced mixed trading sessions in the last few weeks as investors continue to question current valuation.
Above all, the company is facing a serious threat from industry giants, which are threatening Netflix’s dominance in online video streaming in the years to come. Investors have been buying into the company’s growth story, but that now looks increasingly questionable going forward.
