Disney+, Apple TV+, AT&T NOW, Peacock, Prime Video, Hulu... If you're following Netflix (NFLX -1.13%) even the slightest, these names are a resounding chorus on repeat. Netflix CEO Reed Hastings, referring to newly emerging streaming competitors, acknowledged the tough road ahead in a recent Vanity Fair interview in which he noted "a whole new world starting in November,"when big-name competitors are set to launch.
Should Netflix stock owners be worried? Let's breakdown the three most significant risk factors impeding the road forward.
1. Netflix is already being dinged
The clear-cut No. 1 risk for Netflix is competition. With deep-pocketed companies like Apple spending billions to provide streaming options to viewers, Netflix will struggle to retain and gain market share. As Hastings said, "It'll be tough competition. Direct-to-consumer [customers] will have a lot of choice."
Indicators of potential trouble have arrived as Netflix lost 126,000 U.S. subscribers in Q2 of this year, the first such loss since 2011. Additionally, Netflix's share of the U.S. paid over-the-top (OTT) streaming market is estimated by eMarketer to be 87% this year, down from 90% in 2014. Keep in mind streaming is not a zero-sum game. People pay for more than one service.
2. Netflix's debt is on a steady climb
Debt is not always a bad thing, but if it starts to climb too high or isn't being used effectively to drive the business, you've got a problem. You could look at total debt independently, but this can be misleading. A better metric to use is the debt-to-equity ratio, which compares debt to shareholders' equity. The higher this number, the more risk to stockholders because debt has to be repaid. Like many ratios, this one should be looked at compared to companies within the same industry.
In 2014, Netflix's debt-to-equity ratio was 0.61. As of June of this year, it was at 2.06. Regardless of the industry you classify Netflix in, this is considerably high. Debt-to-equity in Q2 of 2019 for the movies and entertainment and broadcasting media industries were 0.02 and 0.09, respectively.
If Netflix is unable to outgrow its growing debt, it may have a problem. In its most recent letter to shareholders, Netflix projected free cash flow of negative $3.5 billion for all of 2019. In other words, way more money is going out the door than is coming in. While this can fuel growth, it's not a long-term sustainable practice and does increase risk for investors.
The debt growth can be attributed to an increase in content spending in an attempt to stay relevant. It's reported Netflix plans to spend upward of $15 billion on new content in 2019. Projected to outspend its closest and newest OTT competitor, Apple, by $9 billion, Netflix could win the content sprint especially with iconic pickups like its 2021 Seinfeld licensing deal.
The question investors need to answer, though, is whether this aggressive spend will deliver the results needed to beat the competition. With many of its new competitors having such deep pockets, it's tough to think they will sit idly and not ramp up spending to compete for market share.
Netflix's core product is quality content. To stay relevant in an increasingly competitive market, Netflix needs to continue spending on original programing and licensing for other shows and movies. Investors will need to keep an eye on whether Netflix can keep up with the likes of Disney and Apple without shelling out too many IOUs.
3. Content changes and price increases upset customers
There's nothing people love more than paying higher prices for less product. Or is that the other way around? As previously mentioned, Netflix lost 126,000 U.S. customers in Q2 of this year, which Hastings blamed on pricing increases unaccompanied by increased content choices. Netflix lost fan favorites The Office and Friends, which no one predicts to be well-received by subscribers.
Are these major shows just heading out to pasture? Nope. They're going to competitors. NBCUniversal will be streaming The Office on Peacock and Friends will be streaming on HBO Max. Customers looking for Jim and Pam at the water cooler or wisdom from Joey will need to look somewhere besides Netflix.
While the promise of new originals and fruits of the $15 billion spend loom for the future, domestic Q2 numbers show the company is moving in the wrong direction. Couple this with recent price increases, and you've got trouble. I may not be an economics expert, but I do know the principles of supply and demand are not supply less content and demand more money.
The future for Netflix is heavily dependent on how it responds to these risks. It needs to outpace the competition, effectively utilize its debt, and start making moves that make customers smile.