Netflix valuation, a House of Cards?

Worldwide fans of Congressman Francis Underwood’s adventures are going nuts for the release of Season 3. Yet the market is not impressed: NFLX share price dropped by 1.68% on the same day.

In fact, analyst widely agree Netflix current valuation (Nasdaq: NFLX) depends heavily on its ability on creating quality original programming and marketing them effectively. The uncertainty on future strategy which causes high volatility and recently determined a fully recovered sharp 26.4% drop needs to be addressed more clearly.

Netflix said its 320 hours of original programming in 2015 actually cost less than most of its licensed content. “We try to make each project more efficient and effective than studio content we’d otherwise be licensing,” the company said in its fourth-quarter investor letter.

house-of-cards-season-3-teaser

For its part, Netflix has been transparent about its ramp-up in spending for original content that brought 45 Emmy, 10 Golden Globe and two Academy Award nominations and several wins in just two years. “We will continue to grow the percentage of our content spending dedicated to originals for the next several years,” the company said. “This will mean more cash usage, which means more debt.” Looking at the number of shows, basically every four weeks we’re going to have something new and fresh to watch on Netflix with House of Cards-like quality. But financially this means using cash and increasing debt for pushing a complicated international growth that is at the moment the most credible growth strategy.

It has also been noted that while concerns over profitability and negative free cash flow appear to be an afterthought for investors right now, at some point that attitude will shift and when that happens, we can expect Netflix shares to trade down significantly from their current levels at 109.84 P/E ratio.

Nevertheless, the recent ruling in favor of net neutrality, the principle that Internet service providers and governments should treat all data on the Internet equally, was a big win for Netflix as product and for the digital distribution sector in general, since ISPs will not be able to discriminate or charge differentially by user, content, site, platform, application, type of attached equipment, or mode of communication.

Season 1 and 2 of House of Cards helped the streaming giant adding globally a total of 3 and 4 million subscribers respectively, whereas the main effect of the new season may be the retention of current customers rather than new subscriptions. The growing curve is slowly flattering and Los Gatos should open up new business opportunities in order to build up new revenue streams if they want to survive the increasing competition, from legal players as well as from piracy, which also causes higher marketing expenditure. One direction could be finding a way to exploit the potential synergies with theatrical day-and-date releases as they are going to do with Crouching Tiger, Hidden Dragon II: The Green Destiny.

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