Unsubscribe from this streaming giant

However, while we do not believe Netflix is a bad company, there are many reasons to question whether it will be as successful an investment over the next decade. FactSet-compiled consensus forecasts suggest Netflix will grow its subscriber base from 247mn as of 30 September this year to over 316mn by the end of 2027, a 28 per cent jump. Much of the stock’s valuation is based on the assumption it will do so handily, while increasing average user revenues and boosting profits.

We are more pessimistic, and therefore see Netflix’s shares as heavily overvalued. Those holding the stock should take their profits and unsubscribe from the rampant growth narrative.

Turn-offs

First, Netflix’s first-mover advantage is eroding fast. While it was once revolutionary in convincing people to pay for an on-demand online streaming service and using that cash to develop original and award-winning films and television, it is now one of many. The most serious of these rivals is Disney (US:DIS), which joined the fray with Disney+ in late 2019. The Magic Kingdom also owns streaming platforms Hulu – whose remaining minority stake it is acquiring from Comcast (US:CMCSA) – and ESPN+, which it bought in 2016 and rebranded as the streaming service it is today in 2018. Although Disney was late to the party, its existing back catalogue instantly rivalled the content Netflix had spent years building up.

In addition to its vast vault of classic films and TV shows, Disney has spent significantly more than Netflix for several years on adding content to its digital war chest. Indeed, Disney was a film and TV powerhouse before it launched Disney+, so even when its only competition with Netflix was ESPN+, it was still outspending it. Subsequently, Disney almost doubled Netflix’s annual spend on licensing and producing additional content in 2020 and 2022. Hot on the heels of both is Amazon (US:AMZN), which matched Netflix’s spend in 2022.

Then there is Disney and Amazon’s history of eyebrow-raising M&A activity. As well as Hulu and ESPN, Disney has gobbled up the Marvel and Star Wars franchises, as well as 21st Century Fox over the past two decades. Not to be outdone, Amazon snapped up MGM, the studio behind the James Bond film series and other intellectual property, last year. These megadeals add thousands of hours of well-known films and TV shows to their arsenals. Netflix has also been a buyer, including the rights to Roald Dahl’s universe, but the sum of its dealmaking looks small by comparison.

There are countless other rivals, too. And switching between them is easy. For the end user, in the US, for example, there is little difference between using Netflix, Apple TV, Peacock, Max, NOW, Dazn, Heyu, Hulu, BritBox, or any other service, except price and content. This is great for the consumer, but tough for the companies competing for eyeballs.

The recent Hollywood writers’ strike adds to Netflix’s content production woes. Although the industrial action is now over, it is likely to reduce television and film output for years. This happened the last time there was a strike, in 2007-08, and which lasted around 100 days. This year’s strike, by contrast lasted around 150 days.

This lag will hurt other streamers too, but few are as dependent on original content as Netflix. Thanks to its mega mergers and age, Disney has a deep locker of films and TV, including anything and everything related to Marvel, Pixar Studios, The Simpsons and Star Wars, which it can sit on while still acquiring subscriptions. By contrast, Netflix’s appeal to subscribers is fresh, cutting-edge television and film. It has well-loved content in its coffers, but not to the same extent as Disney.

Given all this, it is hard to see how Netflix will convince another 69mn subscribers to sign up over the next four years. US and Canada subscriber numbers are flatlining, implying the region is now ex-growth. It is a worrying prospect as they are among the largest and most television-loving economies in the world, and it leaves Netflix’s fortunes in the hands of countries where it has yet to become as much of a household name and whose content tastes could be wildly different. 

In short, we do not know if the rest of the world will like Netflix, whose content is geared to North American audiences. The international appeal of Stranger Things, House of Cards and Breaking Bad reruns is more of an unknown than the multi-decade-old staples owned by the competition, such as Disney and James Bond films. International expansion is also likely to mean thinner margins, as consumers in countries with lower incomes than the US will be more price-sensitive. This is especially true now, as many economies lumber through prolonged periods of economic stagnation.

Disney’s subscriber numbers should both concern and encourage Netflix investors. On the one hand, Disney's streaming subscribers, including EPSN+ and Hulu customers, went from practical nonexistence in 2018 to briefly surpassing Netflix’s count in 2022. However, Netflix reclaimed the top spot after Disney haemorrhaged millions of Indian subscribers earlier this year, blaming its loss of Indian Premier League rights in the cricket-loving subcontinent. Disney’s enforcement of account-sharing policies and price increases were also part of the problem.

Netflix could celebrate this win, but it also looks like a warning of the difficulties of international expansion, price rises and password crackdowns. And Disney could yet overtake Netflix again. It remains a close second after four years of unprecedented subscriber growth.

'Peak TV' or weak TV?

But perhaps the biggest issue for Netflix’s projected subscriber growth is not competition or international markets but the notion that we are past 'peak' TV. Netflix was very much a beneficiary of the pandemic, of a captive audience with nothing to do but stay inside and watch, but now many of those customers want time away from screens (or at least, their TV screens). 

Meanwhile, on the production side, higher interest rates mean there is no ‘free money’ to spend on great television in the way there was during the 2010s. That Netflix's net debt is larger than its total equity does not help in this regard either. Add to this the $14.2bn in off-balance-sheet debt Netflix has in the form of “content obligations”, as in money it has already committed to future projects, and it is difficult to see how the company will have enough financial firepower to keep all its rivals at bay.

Netflix and its defenders will point to the 22.6mn subscribers it acquired this year as evidence of its post-pandemic appeal, but that jump was likely to be at least partly the result of its password-sharing crackdown, which is a trick it cannot repeat twice. If Netflix does not grow its subscriber count, it could squeeze its existing subscribers for more cash or push more advertising on them, but that would make it no better than the cable providers it replaced.

There are positives to Netflix. Its model is profit-making, while Disney's streaming arm is not, and it remains the market leader. But to justify a forward price/earnings multiple of 29, it must prove itself as a growth stock. Similarly valued companies are associated with world-beating technologies. That was Netflix 10 years ago. Today, it is just another streaming app desperate for viewers. It managed to pivot from a DVD-by-post rental model into something completely new, so transformation is not beyond its remit. But we would recommend investors watch something else.