Netflix's (NFLX 1.31%) stock price fell below $200 a share on Tuesday, the lowest level in about four and a half years. The stock is now down a painful 71.7% from its all-time high and 67% year to date.
Slowing growth and increased competition are weighing on Netflix's top line and challenging the feasibility of its 15-year business strategy, which had been to land new customers, keep those customers, and raise prices over time to get more money per customer.
It's time to accept that the days of Netflix's hyper-growth are over. However, that doesn't mean that Netflix can't be a great long-term investment. Here are two different directions Netflix could consider taking from here.
Option 1: Buy Spotify
Netflix's main problem is a lack of growth in a crowded industry. Instead of going toe-to-toe with a growing list of competition, Netflix could be better served by expanding its content medium offerings instead of simply making more shows and videos in the hopes of appeasing subscribers.
Netflix doesn't have an edge in sports. But it could make a play in a less-crowded industry -- music and podcasting. The two players in that industry with the most growth are probably Apple and Spotify (SPOT -0.53%). On its own, Spotify may struggle to continue competing with Apple. But if Netflix bought Spotify, the combined company could have a lot more muscle to flex in movies, shows, music, and podcasts.
The idea isn't as far-fetched as it sounds. Like Netflix, Spotify stock is also down around 70% from its all-time high.
Spotify now has an enterprise value of $19 billion and a price-to-sales (P/S) ratio of 1.9 -- its cheapest valuation since it has been a public company. Spotify reported 406 million monthly active users as of the fourth quarter of 2021, 180 million of which were premium subscribers. In the first quarter of 2021, it earned $2.295 billion in revenue from its premium subscribers and $394 million from its ad-supported subscribers and booked $712 in gross profit. However, it still lost money on the quarter with a $7 million operating loss.
By comparison, Netflix earned $7.87 billion in Q1 2022 revenue and booked $1.972 billion in operating income. Netflix has the profit, but it lacks the growth, whereas Spotify is close to profitability, has a massive subscriber base, and has loads of potential to either monetize that base or grow more from here. Each company's issues can be partially solved by teaming up with a worthwhile partner. Netflix has over $6 billion in cash on its balance sheet and will probably be generating additional free cash flow (FCF) in the coming quarters that could be used toward an acquisition instead of just making more content.
Option 2: Start paying a dividend and repurchasing stock
The second and far less entertaining option would be for Netflix to accept its mediocre growth prospects and start paying a dividend. The company is forecasting the first half of 2022 revenue to be $15.92 billion with $3.7 billion in operating income. Using FCF to pay a dividend and buy back stock when its stock is down 70% from the all-time high would be a sign to investors that Netflix views its business as undervalued.
Investors that think Netflix won't have enough money to spend on new content if it begins paying a dividend are mistaken. Netflix is planning on spending $12.22 billion in the first half of 2022. If it were to spend just $3 billion a year on dividends and maybe $2 billion on share repurchases per year, that would give the stock a more than 3% dividend yield, and it would still have a ton of money to spend on new content. Netflix could then transform itself into a moderately growing, inexpensive stock with a solid and growing dividend.
Paying a dividend and accepting slowing growth would probably be welcomed by investors. Given the Netflix stock sell-off, it has become clear that the market is no longer giving Netflix the premium valuation it once enjoyed. However, the damage seems to have been done, as the stock has a price-to-earnings ratio of 18.3 and a P/S ratio of 3 -- the lowest levels in nine years.
Taking a step back
With its 221.64 million subscribers, Netflix remains one of the most powerful media companies in the world. There have been many headlines about whether it's a good idea to buy Netflix stock on the dip. However, the better course of action is to accept that Netflix will probably never be the company it used to be or have the same advantages it used to have. Therefore, the question isn't how will Netflix compete with other streaming players, but rather, what can Netflix do to make its business stronger overall and build shareholder value?
One of the most enjoyable things as an investor is to think ultra-long-term and ask where you'd like to see a business head from here. I would like to see Netflix buy Spotify or start paying a dividend. If Netflix did that, I think the long-term investment thesis would become very compelling. For now, Netflix stock is so inexpensive that it seems reasonable to open a starter position. But for investors to pull the trigger on Netflix, it will have to do a lot more than toy around with ad-supported content and price hikes.