Netflix Stock: Competitors Are Easing Pressure (NASDAQ:NFLX)

Introduction

My thesis is that Netflix (NASDAQ:NFLX) has a more certain future now that the competitive landscape is becoming rational.

An April 2021 WSJ article notes that Netflix is now using more financial discipline per senior executives. The article quotes Global TV Head Bela Bajaria:

We should right-size budgets depending on what the creative dictates, and what the size of the audience is.

Since the time of that April article, we’re seeing that streaming competitors are also shifting focus from subs to financial metrics. Without Hulu, Disney (DIS) and Warner Bros. Discovery (WBD) combined only have about 2/3rds of the direct-to-consumer (“DTC”) streaming revenue that we see from Netflix. Viewed through this lens as opposed to subscriber numbers, it is easy to see that WBD and Disney don’t have the necessary streaming scale for positive operating income. It would be bad for all companies in the streaming space if WBD and Disney continued to chase subs blindly without worrying about economics, but recent comments reveal that they are being more prudent, especially on the WBD side.

Warner Bros. Discovery

Focused on storytelling, WBD is one of the more direct competitors for Netflix, and the comments WBD made in the 2Q22 call were a bombshell as they talked about dialing back the streaming exuberance and putting more energy back into other businesses. When AT&T owned HBO, management had more of a cutthroat mentality against Netflix, and it seemed that they would neglect their theatrical and linear TV segments. In the 2Q22 call, WBD CEO David Zaslav made it clear that the strategy is changing such that movies will be released in theaters again:

We have a different view on the wisdom of releasing direct-to-streaming films, and we have taken some aggressive steps to course correct the previous strategy.

This change is good for Netflix because it means WBD is a little less tempting as an alternative to consumers now that they’ll have to wait before movies come out on the streaming service.

Historically, Time Warner has made their content available to multiple sources. After AT&T acquired Time Warner in 2018, it looked like this availability would lessen, but CEO Zaslav made it clear in the 2Q22 call that availability will remain open, citing Warner’s Ted Lasso Apple (AAPL) TV example:

And some [content] will lay on other platforms such as Ted Lasso and Abbot Elementary.

Discovery International CEO Jean-Briac Perrette made it clear in the 2Q22 call that they are done chasing subs blindly and that financial considerations will be guiding them moving forward:

We’re targeting the U.S. streaming business to be profitable in 2024 and for the global streaming segment to generate $1 billion in EBITDA by 2025.

He went on to say that price increases are coming and that they will shift away from heavily discounted promotions that boost the sub count but not revenue.

CFO Gunnar Wiedenfels repeated in the 2Q22 call that decisions made by AT&T management are being reversed. AT&T management reduced external content sales and in an effort to prioritize HBO Max, they halted new content licensing deals to third parties. They also limited HBO Max B2B distribution. Investments in kids and animation content were made without measuring the investment case. Capital was put forward towards HBO Max films where the ROI wasn’t there. In reversing these decisions, WBD is now using a framework where capital allocation is based on financial metrics as opposed to subscription races. Netflix has been making decisions based on financial metrics as opposed to sub races for years, and it is a healthier market now that WBD is joining them in this logical approach.

Disney

Like WBD, Disney (DIS) is a formidable competitor, but Disney spends a lot of resources on parks, linear TV and sports in the U.S.

Obviously, it’s bad for Netflix if competitors use heavy discounts and come close to giving their service away for free. Recognizing the value of their unique content, Disney announced price increases on August 10th; Disney+ without ads is going up from $7.99 to $10.99. I believe Disney will focus more on financial metrics than sub counts in the coming years. They’ve started to do this in the quarterly filings, showing that the monthly ARPU for Hotstar subs is only $1.20 which is more than 5 times smaller than their $6.27 monthly ARPU for US and Canadian Disney+ subs. The smallest monthly ARPU numbers for Netflix come from the Latin American segment where they are $8.67, but this isn’t even twice as small as their highest segment, the US & Canada, where the monthly ARPU is $15.95.

Big Tech

Amazon (AMZN) needs to be careful with their Prime Offering as the FTC is investigating them closely. Netflix’s decision in the early days to focus on content outside of live sports was prescient, given the way Amazon is driving up rates for competitors like Disney’s ESPN with efforts like Thursday Night Football. Again, the best show on Apple TV, Ted Lasso, isn’t even made by Apple. Their focus is on iPhones, and I don’t see them posing a significant threat to Netflix in the near future.

Landscape Summary

Looking at the quarter through June 2022, Netflix had an operating profit of $1,578 million on revenue of $7,970 million. Meanwhile, WBD had a DTC streaming operating loss of $(1,534) million on revenue of $2,410 million and Disney DTC including Hulu had an operating loss of $(1,061) million. The quarterly DTC revenue of $5,058 million for Disney needs to be clarified because more than half of it is from Hulu, which is not an apples-to-apples comparison with Netflix and WBD DTC. These disparate operating income and revenue numbers show that the subscriber numbers of 220.7 million, 92.1 million and 152.1 million for Netflix, WBD and the Disney+/ESPN+ combo, respectively, are not very telling. Again, one of the problems with Disney is that their 58.4 million Hotstar subs have a monthly ARPU of just $1.20 each, such that they generate less than a quarter billion of quarterly revenue.

Valuation

Headlines focus too much on where streaming competitors stand relative to each other, without acknowledging that the size of the streaming pie is continually growing relative to cable and broadcast.

Nielsen shows that in the US, streaming has jumped from 28.9% of TV share in January to 34.8% just 6 months later in July. Despite facing more streaming competition than ever, Netflix has gone from 6.6% of TV share in January to 8% in July.

Given how the competitive landscape has become more sensible over the last month, my valuation thoughts are more optimistic than they were at the time of my July 22nd article. Netflix’s stock has come up some since the time of that article, but I still think it is undervalued.

Disclaimer: Any material in this article should not be relied on as a formal investment recommendation. Never buy a stock without doing your own thorough research.