Netflix: A Short Opportunity

Things are heating up for the erstwhile streaming leader Continue reading... Read More...

Traditionally, the majority of value investors tend to be long-only. But occasionally, a short-side opportunity that should appeal to value investors will present itself. After all, selling high and buying low is not so different from buying low and selling high (although the psychological aspects of short-selling should not be dismissed). I believe that Netflix Inc. (NASDAQ:NFLX) currently presents such an opportunity.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Competition” data-reactid=”18″>Competition

Netflix burst onto the streaming scene in the early 2010s by offering users a low-price way to watch a large amount of content on a single, easy-to-use platform. It was one of the first movers in this area and, as such, had an outsized bargaining position when it came to negotiating licensing fees for content. This has changed in recent years, with many more streaming services coming online.

One prominent example of these shifting sands is Disney (NYSE:DIS), which is in the process of rolling out its own streaming service and is pulling content from Netflix. Disney owns massively popular franchises like Star Wars and Marvel, as well as its beloved animated films, making it a serious force to be reckoned with.

Other competing streaming services include Amazon’s (NASDAQ:AMZN) Prime, Hulu (two-thirds of which is owned by Disney, one third by Comcast (NASDAQ:CMCSA)) as well as Apple’s (NASDAQ:AAPL) Apple TV. Netflix’s lofty valuation was always based on being an early mover; now it faces competition from some of the biggest companies in the world.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Cost of content” data-reactid=”22″>Cost of content

Netflix burns cash at an impressive rate, even by today’s standards. This year alone, it is expected to lose $3.5 billion on revenues of $20 billion. Management has long assured investors that this shortfall will be made up over time as subscriptions rise; however, there are reasons to believe the gap will continue to widen. For one thing, increased competition may force Netflix to cut its subscription fees. For another, the cost of content licensing has increased over the last several years as the number of willing buyers has also increased.

Netflix also loses money producing original content. While some of it is undoubtedly high-quality television, it lacks the rewatchibilty factor that is ultimately required to generate cash long term. Its most popular shows are not native to Netflix, which puts it in a precarious position. “Friends,” one of the most-viewed shows on the streaming service, is set to be pulled from Netflix in 2020 – its owner WarnerMedia is launching its own service, called HBO Max. The same goes for “The Office,” another Netflix favourite, which is being pulled by NBCUniversal in 2021.

In short, the problem for Netflix is twofold: increasingly hostile competition and increasingly costly content. Meanwhile, its share price is still far higher than it was when it went on its 2018 bull run. That seems too high.

Disclosure: The author owns no stocks mentioned.