WHY NETFLIX IS CRASHING
Felix Salmon at Reuters has a succinct explanation of why Netflix stock is crashing. (Note to non-investors: a stock and a company are two different things. A stock looks at not only current value but future growth potential. Thus, a good company with a healthy but slowly growing business can be worth less than a similarly sized company that might be losing money but is expected to grow into larger earnings.)
In a post titled “Why Netflix Stock is So Volatile,” he explains that Netflix’s meteoric rise to a $300 share price drove short sellers from the stock. Then, when the stock started to decline following its price-hike and the botched Qwikster spin-off, there were fewer shorts ready to cover and thus prop up the share price. Yesterday’s quarterly earnings report showing larger-than-expected subscriber loss and the high costs of expanding into new markets turned Netflix into a momentum stock on the downside.
Interestingly, Salmon also writes about how Netflix’s rising stock price emboldened both the company and the studios to strike extremely rich content deals that the company may now have a hard time matching.
And suddenly investors started looking at corporate fundamentals, and asking questions about whether streaming operations could ever be hugely profitable for Netflix — or even profitable at all. The dynamics of the rising share price were clear: every time that Netflix looked as though it was making lots of money, the price of the next streaming deal would only go up. Netflix has to buy streaming rights from big-media companies, and those companies are going to extract as much money as they can from Netflix, up to and possibly even beyond the point at which it declares bankruptcy. It’s the big-media companies which have the pricing power here, and now that Netflix has set eye-watering precedents for things like DreamWorks Animation and House of Cards, it’s going to find it difficult to pay more reasonable rates going forwards.
So people with equity in Netflix are in a difficult place. Their company is locked into a model where it pays billions of dollars for streaming rights, while keeping the price to subscribers dirt-cheap. That’s a model which on its face looks much more attractive to the content creators than it does to Netflix. And it’s very hard to place a value on the permanent equity of Netflix in that kind of dynamic. When it was going up, it was going up. But now it’s crashed so dramatically, no one has a clue where Netflix stock should be trading, or even whether Netflix — having largely abandoned its DVDs-by-mail business model — even has a viable model at all.