Look Out Above -- Netflix, Inc.'s Content Costs Are Rising Faster Than Everhttp://www.fool.com/investing/general/2014/02/08/look-out-above-netflix-incs-content-costs-are-risi.aspx Adam Levine-Weinberg
February 8, 2014
Netflix (NASDAQ: NFLX) has had no trouble adding to its global subscriber base in the last two years. It has recovered strongly from the "Qwikster" debacle of 2011, growing from 25.6 million global subscribers in mid-2011 to more than 44 million by the end of last year.
However, despite rapid revenue and subscriber growth, Netflix's earnings power still has not recovered to pre-Qwikster levels. (The company posted its best-ever quarterly EPS of $1.26 in Q2 2011.) Netflix should be able to retake that level in 2014 or 2015, but its long-term earnings growth potential is not quite as great as bulls project.
Rising content costs are the key factor that has prevented Netflix from turning its rapid revenue growth into big profits. Moreover, the company's recent annual report provides further evidence that content costs will continue soaring higher, keeping earnings well below a level that could support Netflix's $400-plus stock price.
Content costs rising
Netflix attributed $226 million of that increase to higher content licensing costs. The remaining $64 million increase was the result of higher costs for things such as content delivery, payment processing, and customer call centers.
Content costs rose even more quickly outside the U.S., as Netflix has more work to do to build up its content library in international markets. In 2013, "cost of revenues" skyrocketed by $299 million -- or 63% -- for the international streaming segment. $272 million of that increase went to content licensing.
Revenue growth is not enough
When all was said and done, the big increase in content costs -- along with smaller cost increases in other areas -- meant that Netflix grew its adjusted net income by a little more than $100 million last year. That looks very impressive next to the company's paltry 2012 net income of $17 million.
However, Netflix's market cap is now roughly $25 billion. Even if Netflix continues growing adjusted net income at the same rate through the end of the decade (about $110 million per year, on average), net income would still be less than $1 billion in 2020.
It seems clear that investors have higher hopes than that for Netflix. If Netflix's net income is still below $1 billion in 2020, the stock would need to trade for nearly 30 times earnings (well above the market average) just for the stock to stay at $400. For Netflix stock to beat the market, it will need much more earnings growth by then.
Content costs will continue rising
If content costs represent 85% to 90% of the streaming "cost of revenues," Netflix spent between $2.23 billion and $2.36 billion on streaming content last year. The guidance therefore suggests that content cost growth will exceed last year's $500 million figure in 2014.
Netflix's cash outlays will be even higher: The company already has $2.97 billion in content commitments for 2014. That does not include pa