Netflix (NFLX 2.51%) shareholders have been on a wild ride since the onset of the pandemic. At first, it surged as hundreds of millions of people spent most of their time at home, and demand for home entertainment exploded.
Now that economies are reopening and people are spending less time streaming content, Netflix grapples with the increasing amount of competition that entered the fray during the pandemic and slowed their growth. For those investors on the sidelines considering acquiring shares of Netflix, it helps to acknowledge the bull and the bear cases.
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The bull case
Netflix enthusiasts are quick to point to the scale of the streaming giant. As of Dec. 31, 2021, it boasts 222 million subscribers, up by 8.9% year over year. The figure is enough to crown it the industry leader in streaming content.
One benefit of that level of scale is the robust recurring revenue it generates. By the fourth quarter of 2021, Netflix's revenue was at an annual run rate of $30.8 billion. What makes that so powerful is that Netflix can reinvest large sums in adding content to the platform. The fresh and attractive content keeps existing members engaged and attracts new members. It has taken Netflix over a decade to build this scale, and it will be difficult for competitors to match.
In recent years, Netflix has managed the business to add content and increase profit margins. From 2016 to 2021, Netflix's operating profit margin expanded from 4.3% to 20.9%. Impressively, Netflix achieved this feat while spending $11.8 billion on content additions in 2020 and $17.7 billion in 2021.
The bear argument
The bear's argument likely concedes Netflix's impressive growth in the past. Instead, it will focus on the slowing growth right now and reduced expectations in the near and medium terms. For its fourth quarter ended December, Netflix had forecast it would add 8.5 million subscribers but missed that figure by 200,000.
What's more, its forecast for the next quarter of 2.5 million additions is far below its historical average for the first quarter. Since 2017, Netflix has added an average of 8.4 million subs in Q1; the estimate for Q1 2022 is 5.9 million below that value. The lower-than-expected forecast may not be as concerning in and of itself. However, it has taken heightened importance since several big players entered the streaming industry. Netflix's slowdown could indicate a depletion of competitive advantage. It's all the more troubling that most competing streaming services are priced well below that of Netflix.
Rising competitive forces are rarely a good sign for a business. It's forcing a decision on Netflix's management that was, for the most part, non-existent before the pandemic onset. Netflix must decide how it will respond to the rising threat. Will it boost content spending to attract and retain subscribers that might consider jumping ship? Or will it lower prices to bring itself down closer to industry peers? Regardless, both choices lead to decreasing potential profitability.
The lose-lose choice in front of Netflix could be why the bears are winning the argument, and Netflix's shares have been down 43% in the last three months. No matter who wins the streaming wars in the long run, the battle is likely to be expensive.
