Join the debate: Is it time to short Netflix?

As the finance nerd that I am, I had quite a fun time yesterday getting in an email discussion with a reader about whether or not to short Netflix (NFLX) now. Netflix was the market darling for much of the past year, but things fell apart a bit for Netflix in October. They reported slowing subscriber growth in their earnings report and the stock price tanked. The question we were debating: is Netflix going to keep going lower?

I am on the con side of this argument. I think Netflix is transforming the cable/entertainment industry and still has a lot of long term growth potential. I actually have 5 shares and am planning to hold on to them for a while.

But my reader made some good points in support of selling the stock short now. He thinks Netflix doesn’t have the infrastructure the cable companies do, or the power to create content like the big producers do. He’s planning to short Netflix and aiming for the price to reach around $300 per share.

[Note: selling a stock short means you are borrowing shares to “sell” now, and you will actually buy them later. You profit if the share price drops because you bought the shares for less than you sold for them.]

Rather than keep the thoughts stuck in my inbox, I thought I’d bring them over to the blog! Now for a rundown of the pro/con arguments:

Netflix can’t replace cable

“The theory is that you really only need 2 players in the video / TV content market: 1) the people producing the content and 2) a medium to deliver that content to the end customer. Role number 1 can be fulfilled by players like HBO or Disney’s conglomerate who can make the content and display it on their websites. Roll number 2 can be fulfilled by the cable / phone companies (Verizon and Comcast). It is going to be hard for Netflix to stay in the middle of those 2 aspects and charge another fee.

I agree that cable’s prices are exorbitant and will come down. I just don’t think Netflix is going to be able to provide the infrastructure to deliver content (like cable lines or fiber lines). Therefore I think the cable companies are needed in some way and I think content creators are needed in some way.”

Netflix doesn’t generate enough money to keep creating great content

“Netflix does have some of their own content, but that only goes so far. The cable companies have a monthly subscription of around $90 on average per person, and they spend $40 of that on content. Netflix on the other hand has only $8-10 of monthly subscription revenue per user, so there isn’t even close to as much money to produce content.”

(Quotes from my awesome reader).

Big cash bets could go bad

Netflix has made a lot of big moves recently, including expanding to new countries and acquiring new original content. But those plays come at a big cost. Netflix’s hotly anticipated new show, Marco Polo (debuting Friday) reportedly cost the company $90M just for the first 10 episodes! If those costly bets don’t pay off in the form of new subscribers, investors will likely take out their frustration on the stock price.

(That’s my own devil advocate’s point).

The number of households choosing Netflix over cable will continue to grow

Everyone hates Comcast. The end.

Ok, that was an exaggeration, but sometimes it feels like what every one of my friends says. Comcast and the cable providers charge exorbitant monthly fees, for often terrible customer service and reliability. In response, many young adults have become “cord cutters.” A cord cutter is someone who may pay for internet but not cable or satellite TV.

Today, about 6.5% of households do not pay for cable TV, up 2% from 2010. And that number is actually double among 18-34 year olds, with 13% not paying for cable TV. The number of households without cable TV is expected to grow, and according to surveys about 15% of current pay-TV subscribers are considering dropping it. As young adults graduate and move into their own apartments, I think they will drive up the number of households without cable TV.

What are people using instead? Internet streaming services. While pay-TV subscribers are sliding, broadband internet subscribers (how people access Netflix) are growing significantly.

Even with the price increase, Netflix (heck, even Netflix plus HBO Go) is just a fraction of the cost of cable, key for young adults not making much money. I don’t think cable TV’s high prices are sustainable, and as a result more consumers will turn to Netflix.

Netflix is becoming a content power-house

In addition to price, Netflix’s main value driver is its content. Netflix produces addictive TV series. Since their original content is only available on the service, anyone needing their Orange is the New Black or House of Cards fix (I require both) has no choice but to keep paying for Netflix.

And Netflix’s original content is only getting stronger. Netflix now has Marco Polo and a slate of new features to come. It signed deals to stream new content from Adam Sandler, Chelsea Handler, and even Tina Fey’s new comedy. It seems like Hollywood power players are starting to view Netflix as the new frontier to air your quality content.

International expansion

Even though domestic subscriber growth was disappointing last quarter, Netflix may make up for it with international expansion. Netflix is now available in 13 European countries, and recently announced it will be available in Australia and New Zealand in March 2015. The company will make Marco Polo and House of Cards available internationally as well.

Now that I’ve run through our points, I would love to hear what you all think! Jump into the discussion in the comments section.

Which direction do you think Netflix is headed in?