Netflix’s (NFLX, Financial) growth has been very impressive. That being said, the company’s growth has been fueled by increasing content investment. While spending heavily on content has helped Netflix up to this point, I do not think this strategy will be sustainable for the long run.
The heavy spending on content has led to strong growth in the number of subscriptions both domestically and internationally. However, it seems the company’s days of strong subscriber growth are coming to an end, especially in the domestic market.
Netflix has achieved incredible growth due to the heavy spending on content, however the growth has not created any long-term value for the company as its net income for fiscal 2015 was just $122.5 billion. To put it into perspective, Netflix currently commands a market cap of $50 billion, which makes it almost impossible for the company to ever justify its valuation.
Netflix will need to increase its subscription costs dramatically and reduce its expenses in order to grow into its current valuation over the next several years. However, an increase in subscription rates will result in slower growth for the company.
While Netflix’s tactic of spending heavily on content has worked thus far, it is unlikely to continue working in the future. In addition, the company's growth was fueled by debt and this could spell further trouble for the company in the future as interest rates are expected to tick up.
Currently, Netflix has a debt of $2.37 billion, as opposed to total cash of just $1.34 billion. Funding growth by taking on debt works well in a declining interest rate environment, but the strategy is not sustainable in an increasing interest rate environment and will backfire if Netflix continues taking on more debt.
However, given the overvaluation of the stock, debt is not a big problem for Netflix. The company can easily initiate a secondary offering to pay off its debt, but it will still be bad for long-term investors.
Final words
Netflix investors have a lot to worry about going forward. Whether it is the increasing interest rates, increasing competition or heavy expenditure, things do not look very bright for Netflix going forward. With the stock already trading at a trailing price-earnings of over 300, I do not think it has much upside left at current levels. Thus, I think investors should consider selling the stock.
Disclosure: No position.
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