What if Netflix’s Content Acquisition Costs Outpace Revenue Growth?

-17.26%
Downside
606
Market
502
Trefis
NFLX: Netflix logo
NFLX
Netflix

Netflix (NASDAQ:NFLX) incurs costs to keep its content catalog fresh and updated.  Content acquisition costs (as a % of revenues) inched marginally upward from 14% in 2006 to 17% in 2007 [1], due to more content titles being acquired and the average cost of acquisition witnessing a slight increase as well. Since 2007, the costs have been declining steadily, and we expect it to stabilize at around 13%.  This decline is attributed to faster growth in revenues which offset rising content acquisition costs.  This is a good trend for Netflix, but it may not persist if Netflix’s subscriber growth (and consequently revenue growth) slows.

We currently have a Trefis price estimate of $88 for Netflix’s stock, about 45% below the current market price of $155.

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Content acquisition expenses consist of costs incurred by Netflix in obtaining content from studios, distributors and other suppliers through direct purchases, revenue sharing agreements and license agreements. Netflix cannot afford to reduce the number of titles it acquires due to the competitive environment in the media industry.  Netflix competes with cable and satellite providers like Time Warner Cable (NYSE:TWC), Comcast (NASDAQ:CMCSA), Dish Network (NASDAQ:DISH) and DirecTV (NASDAQ:DTV), and video rental services like Redbox.

Cable operators like Time Warner Cable and Comcast offer video-on-demand services that compete with Netflix’s DVD-delivery and on-demand services.  If these services were to slow subscriber growth for Netflix, it could have a negative impact on the company’s margins if growth of Netflix’s content acquisition costs were to outpace revenue growth.

The average of Trefis member forecasts for Content Acquisition Cost (As % of Revenues) indicate an increase from 14% in 2010 to 14.3% by 2016, compared to the flat baseline Trefis estimate of around 13% over the Trefis forecast period. The member estimates imply a downside of 2% to the Trefis price estimate for Netflix’s stock.

You can drag the forecast trend-line above to express your own view, and see the sensitivity of Netflix’s stock to Content Acquisition Cost (As % of Revenues).

Our complete analysis for Netflix’s stock is here.

Notes:

1. Content Acquisition Cost (As % of Revenues) is calculated as: Content Acquisition Cost/Revenues. We estimate content acquisition costs using guidance given in the company’s annual SEC filings.