Every now and then you do need a contrarian point of view to shake up your own. And if that view comes from a reputable source, then you have to sit up and take notice.
Barron’s Magazine said earlier this month that Netflix (NFLX, Financial) stock could plunge by more than 50% by the end of 2020. That’s a shocking assessment for a company that has grown its user base rapidly over the last few years so let's take a closer look at the argument.
Why Barron's thinks Netflix has a huge problem
“It is chiefly a hit renter, not a hit owner. Even among the expanding universe of Netflix Originals, top performers like 'House of Cards' and 'Orange Is the New Black,' which have both run for five seasons, are licensed, not owned. There is only one example of an owned Netflix hit reaching a second season – 'Stranger Things,' which returns in October.” – Barron’s
While this argument is true right now, what are the odds that it will be true five years from now? To understand that, we need to remember the road Netflix took to get here. Netflix started off as a DVD sales and rental company. Then it moved into streaming licensed content, a great alternative to renting, as users can watch their shows and movies online. As it slowly piled on the users, the company kept shrinking its licensed content library and went after original programming.
Even now, the company still buys hit content: "House of Cards" and "Orange Is the New Black" are great examples, as Barron’s points out. But could Netflix have created it on its own? The clear answer is that it wants to, and that’s the direction it is slowly moving toward.
But there’s a big hurdle on that road: the media production industry is not as simple as it might appear to some and is one of the riskiest. You can often end up spending billions of dollars, only to create a dud that no one wants to see. There are plenty of production houses which, despite their experience in the industry, spend mind-boggling sums of money on films that bomb at the box office.
As such, the risks are way too high for Netflix to take a 100% plunge and spend all its money toward production and only stream its own content on its platform. What the company is doing is keeping a mix of licensed content, rented hits – as Barron's says – and slowly working its way toward producing its own hits. It will burn cash either way as Netflix tries to differentiate its content from that of other providers, and that process will take plenty of time and cash to work in its favor.
This is one company that has repeatedly shown the ability to adapt to a fast-changing environment. When internet user growth was exploding in the U.S., Netflix didn’t sit back and say: “No, we will stay true to our sending-DVDs-by-mail concept.” It got into streaming in a big way. And, when streaming took off, it didn’t say: “We will keep building our licensed content library and stay put with it.” At that point, Netflix wanted to get into original programming. That’s how adaptable and lithe the company was and still is.
Barron’s concern is not unfounded, but I disagree with its assessment that Netflix’s current strategy is flawed. The hits are bound to come eventually. When you put that much money and effort over that amount of time, there’s a very high probability of succeeding, especially now that Netflix has such a diverse spread of users across almost 200 countries.
This is the best strategy that balances risk and reward for the company while keeping things moving forward toward its ultimate goal of a original-programming-heavy content portfolio. And if the status quo is disrupted, we can be confident that Netflix’s management isn’t going to sit still and wait for the worst to happen.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
