Shares of Netflix, Inc. (NASDAQ:NFLX) has fallen more than 13% since its February highs, a far worse stumble than the S&P 500’s 2% dip in that time.
This drop isn’t just another mild pullback like NFLX stock has seen in the past, either. NFLX stock investors have real reasons to be worried.
Content Costs
Netflix’s biggest issue is the cost of content. The company must continually have good content to keep subscribers from leaving the service. But the issue is how much it can afford to pay for that content.
The recent report that NFLX pulled out of negotiations with Sony over the rights to the Seinfeld series, presumably due to price, could be a clear warning sign that the company will not be able to compete in the streaming video arena moving forward.
How expensive are we talking? Well, Sony is expected to bring in more than $500,000 for each of Seinfeld’s 180 episodes.
Netflix has paid large amounts for other content; the company reportedly paid $500,000 an episode for the sitcom Friends. Perhaps Netflix has discovered that the rewards weren’t worth the cost with Friends, or perhaps it’s just unwilling to spend that much money on a single series again.
Newer shows Netflix decided to fork over big bucks for were The Blacklist, Gotham, and The Walking Dead, reportedly paying $2 million, $1.75 million and $1.35 million per episode. These are all rather popular shows, but they come with very high price tags that Netflix may not be able to afford for much longer.
At the end of 2014, Netflix’s total content obligations sat at $9.4 billion. Furthermore, on February 2, the company increased its long-term debt from $900 million to $2.4 billion after taking on $1.5 billion in long-term debt. The company explained that it would be financing original content with this long-term debt.
The original content is not the worst place to be spending money, except when you drop $90 million on Marco Polo, what most consider a flop.
Clearly content is the company’s largest expense, but with an ever increasing number of companies moving in on the streaming business, that content will only continue to get more expensive.
NFLX Stock Faces More Competition
And as that content gets more expensive, Netflix will not likely be able to continue to borrow in order to fund the purchases. After the last debt issuance, the major rating agencies cut NFLX’s credit rating; Moody’s from Ba3 to B1 while S&P moved from BB-minus to B-plus.
On the other hand, Netflix’s competitors all have plenty of money to burn. Hulu, Yahoo! Inc. (NASDAQ:YHOO) and Amazon.com Inc. (NASDAQ:AMZN) are all reportedly gunning after that Seinfeld deal that Netflix just passed on.
The three companies all make the bulk of their cash outside of streaming business. Their streaming services are simply complimentary offerings to their core businesses. If they lose money in streaming video, it’s not going to put them under. For Netflix, though, streaming is everything.
With Apple’s announcement that it will be entering into the video streaming business and already having had signed deals with major networks such as ABC, CBS and Fox for the rights to stream new content, it will certainly be interesting to see how much the rights to those new programs are being sold for.
Unfortunately for NFLX stock investors, the price tag won’t be cheap.
Bottom Line for NFLX Stock
Anyone investing in NFLX stock needs to watch content costs very closely. Those costs will only continue to rise, making it more difficult for Netflix to gain access to the top programs. NFLX is at risk of entering a vicious cycle of customers canceling their subscriptions, leaving Netflix with less cash to pay for content.
We have only just begun to see Netflix fall. NFLX stock has a long way to drop, so investors should sell and stay away.
As of this writing Matt Thalman did not own any of the aforementioned securities. Follow him on Twitter@mthalman5513.
