Netflix (NASDAQ:NFLX) has flourished in the U.S. despite the presence of competitors like Apple’s (NASDAQ:AAPL) iTunes, Amazon (NASDAQ:AMZN) and Hulu. The biggest threat to Netflix’s growth in our view comes from its own business model that could face significant increases in content acquisition costs going forward. New streaming deals with broadcasters as well as exclusive rights for content are recent moves that show that Netflix’s growth could come with a much higher cost base as well. We acknowledge that a significant decline in DVD related costs as a proportion of revenues will help offset these pressures to some extent.
Our price estimate for Netflix stands at $221, about 5% below the market price
New Content Deals Show Cost of Content
Netflix’s deal with Epix in 2010 has added additional $200 million of annual content acquisition expenses for the company for the next 5 years. Netflix has also signed deals with CBS (NYSE:CBS) for both national and international streaming. We expect that Netflix will sign many more similar deals over the course of the next few years that will add to expenses.
In addition to this, Netflix is stepping up and looking to acquire exclusive rights to new shows with the first and the only example so far being ‘House of Cards’. Exclusive acquisition will cost even more. Consequently we expect Netflix’s content acquisition costs to increase past 30% of revenues by end of our forecast period. This is a necessary investment as streaming adoption has been very encouraging in the U.S. and Canada and will provide a strong base for further expansion.
On the surface this might look huge jump but the increase in these costs will be accompanied by a declines in DVD related costs such as the costs of revenue sharing, postage & packaging costs and DVD shipment center costs.
Our estimates are based on the estimated decline in DVD shipments and our long term expectations for Netflix’s overall gross margins.
