What's Next for Netflix Stock: Boom or Bust?

By Markets Fool.com

Streaming video leader Netflix has been a battleground stock for the last few years. The sparring between bulls and bears continued this week, with Evercore analysts telling investors to dump Netflix stock, while Stifel's team urged investors to buy even more shares.

Continue Reading Below

Rising competition
First, Evercore analyst Ken Sena cut his rating on Netflix stock from hold to sell on Monday, and reduced his price target from $450 to $380 -- nearly 10% below the current stock price. He highlighted rising competition in the streaming-video market. Sena believes that this will force Netflix to increase its content spending even further.

While Netflix has faced competition from both Hulu and Amazon.com for the past several years, various new streaming-video options are starting to show up. To give just a few examples, HBO will soon debut its long-awaited streaming-only service, HBO Now. Yahoo! is putting an increasing amount of effort behind its streaming-video platform, Yahoo! Screen. It is looking to make an even bigger splash by bidding for rerun rights to the wildly popular 90s sitcom Seinfeld, according to The Wall Street Journal.

The streaming video market is starting to get more crowded.

Even DISH Network represents a potential challenge to Netflix through its new Sling TV streaming service. While Sling TV serves up live TV as opposed to Netflix's on-demand model, DISH is making live TV a lot cheaper. (This could potentially shift cord-cutter dollars toward live TV -- but it could also help Netflix by encouraging more cord cutting.)

Continue Reading Below

Some of these new competitors will be bidding for original and exclusive content against Netflix. They will all compete with Netflix for viewers. To some analysts, like Sena, this is a recipe for slower domestic growth, a lower profit margin, and a lower price for Netflix stock.

King of the hill?
Stifel analyst Scott Devitt quickly came to Netflix's defense on Tuesday. He argues that worries about rising competition are overblown. In particular, he thinks that the launch of HBO Now will be a "non-event" for Netflix, because of its higher price ($14.99 vs. $8.99 for the standard Netflix package), its potential role in encouraging more people to cut the cord, and the loyalty of most Netflix subscribers.

Devitt also believes that many investors are undervaluing Netflix's international growth opportunities. Netflix is working to complete its global expansion by the end of next year, and Devitt expects this to help it reach 100 million streaming video subscribers globally by the end of 2017, up from 57.4 million at the end of 2014. In fact, Devitt is so unconcerned by the recent worries surrounding Netflix that he didn't just tell investors to stay the course: He recommended doubling down by buying even more Netflix stock.

The content cost question
In the competition for subscribers, Netflix has the advantage of having the deepest catalog of movies and TV shows. As a result, it should remain a leader in the subscription-video market, along with HBO, which has a stronger stable of original content and better access to recent movies.

Furthermore, plenty of people -- especially cord cutters -- may subscribe to more than one streaming-video service. Thus, competition between Netflix, Amazon, Hulu, HBO, and others isn't a zero-sum game.

The bigger risk for Netflix stock is the cost of this competition. Even if Netflix can keep adding millions of domestic subscribers a year for the next several years, that won't drive rapid profit growth if costs spiral out of control due to content-bidding wars.

Content costs have been rising rapidly at Netflix up until recently.

Indeed, Netflix's content costs have risen at a breakneck pace in the last few years. "Cost of revenues" for the domestic streaming segment -- which is a proxy for content costs -- rose 18.6% in 2013, from $1.56 billion to $1.85 billion. Domestic cost of revenues rose more than 18% again in 2014, reaching $2.20 billion.

That said, Netflix's recent financial results indicate that content cost growth may finally be slowing. Quarterly content costs rose by 11% from Q4 2013 to Q2 2014, but by only 5% from Q2 2014 to Q4 2014.

This could mean that Netflix's growing original content library is allowing the company to rein in spending on licensed content. In the long run, owning content is likely to be much more cost-efficient for Netflix, because it can use that content worldwide instead of having to pay for rights in each country where it operates. On top of that, original content is a strong brand differentiator, so Netflix gets more bang for its buck in several ways.

The trajectory of content costs will have a big impact on Netflix stock's performance during the next few years, particularly as the company starts to saturate the U.S. market. The last few quarters of results bode well. However, I'll be paying close attention to Netflix's content cost growth during the next few quarters to see if this is an anomaly or a new trend.

The article What's Next for Netflix Stock: Boom or Bust? originally appeared on Fool.com.

Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Netflix, and Yahoo. The Motley Fool owns shares of Amazon.com, Netflix, and Yahoo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.