Please ensure Javascript is enabled for purposes of website accessibility

Why Netflix Shares Took a Little Dip After a Great Q3 Report

By Motley Fool Staff - Oct 24, 2017 at 9:10PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

After a steep run up in 2017, even beating estimates wasn’t enough to lift the streaming leader this time.

In this segment of the Motley Fool Money podcast, host Chris Hill, Million Dollar Portfolio's Jason Moser and Matt Argersinger, and Total Income's Ron Gross discuss how high the expectations are for Netflix (NFLX 2.90%) in the wake of its third-quarter report.

Investors have pushed the price to a remarkable P/E ratio. The growth in subscribers seems to justify the move. But its content cost per user is outstripping revenue per user, and that could be a big problem.

A full transcript follows the video.

This video was recorded on Oct. 20, 2017.

Chris Hill: Shares of Netflix down slightly this week after a third-quarter report, Matty, that is strong by any objective measure. They brought in 5.3 million new subscribers. Once again, that was higher than expected. Is it just because the stock is so insanely high right now?

Matt Argersinger: And it's had such a tremendous run this year. So the fact that it's given a few percentage points after what otherwise were great earnings, I'm not surprised. But you said it -- subscriber numbers are really the story. The international subscriber numbers of 44% year over year, that just blows away anything that investors, including me, were thinking they could do this year. And that's really been the story.

I thought there was an interesting quote by CEO Reed Hastings on the conference call. We talked about Netflix's market opportunity as "How many broadband users are there in the world, how is that growing, and what kind of share of that can Netflix get?" On the conference call, he said, "Well, I tend to think of it as people. All the people in the planet will get the benefit of the internet over the next 20 years, and we hope that all of them will get to enjoy Netflix also."

Hill: [laughs] His addressable market is the entire planet?

Ron Gross: That's a business plan.

Argersinger: So maybe a new benchmark there for market opportunity. I think that's important for a number of reasons. I think if you buy Netflix right now at today's price, at an $85 billion market cap, at a valuation that a lot of investors would call insane, I think you have to believe that this is a company that can achieve, within a reasonable amount of time, something like over 500 million subscribers. Because the content cost for this business is going the wrong way. They're going to spend between $7 [billion] and $8 billion on content next year, some think $17 billion over the next few years. I think that number gets revised up. The content cost per subscriber is growing faster than the revenue per subscriber. That's unsustainable. Can they get to a point where that number plateaus and the subscriber number continues to grow? That's where they need to get.

Hill: Jason, when you think about how Netflix recently announced they were raising prices, to a person, we all agreed, of course they have that pricing power. But as Matty indicated, if the costs are going up higher than their ability to raise prices, maybe not in the next year or two, but starting in 2020 and beyond, this becomes a serious problem.

Jason Moser: And I'm glad you brought that up, because it's sort of what sticks on my mind in regard to Netflix. What we track quarter in and quarter out is the growth in that obligation, that content obligation, versus the growth in revenue. Revenue, at some point or another, they're going to have a saturated user base. So the growth in revenue is going to have to come from price increases, to some extent. And I just wonder how far they can go with that. I mean, I think it's fair to expect that they will raise prices every year to two years.

Now, as long as they can keep a core, simple, low-cost option for all viewers out there, that will probably behoove them, and then offer sorts of step plans from there for different sorts of definition or how many viewers, or what have you. But that's the question that I keep on coming back to. How far can they really take that pricing? I think in the near term, it's a pretty easy no-brainer that they can keep on escalating prices. But 10 years down the road, I'm not sure. They're going to be beholden to those content costs, I think, in perpetuity.

Gross: Call me a dumb value investor, but all those great things we said could happen -- content costs mitigating and growth going up and prices rising -- that's got to be baked into the current stock price to support this kind of a market cap. So they would have to exceed all those amazing things we just said for the stock to continue to be a good investment. Why would I put my money into a bet like that?

Argersinger: I think what's probably not priced in is Netflix, in 10 years, is the dominant internet TV platform. In other words, it reaches what Reed Hastings says, which is, most people in the world having a Netflix account. I think that's going to be hard to achieve. When Amazon is spending billions, Apple says they're going to spend over a billion, I think YouTube is ramping up their spending on content, Hulu, the list goes on. Can they maintain a brand that people recognize, that people want to subscribe to, that's a familiar app for most people in the world? That is a heck of a goal to shoot for.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Netflix, Inc. Stock Quote
Netflix, Inc.
$179.95 (2.90%) $5.08

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/02/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.