Move Over Peak Oil, This Market is About to Top Out

Explosive growth in shale production seems to have caused calls for peak oil production to be rescinded, but there’s another market that could be reaching peak territory.

About 500 scripted TV series are expected to air in 2017 on broadcast television, cable and web streaming, according to FX Network Research. That’s more than double the 216 shows aired in 2010, and the growth in programming stands in stark contrast to some recent data on streaming trends.


Strategy Analytics expects U.S. consumers to spend $6.62 billion for streaming services in 2016, a 22% increase over 2015. That kind of growth would be enviable in just about any other market, but it marks the first year-over-year decline in spending growth on streaming services, coming in well below last year’s 29%.

While growth appears to be slowing, entertainment and media companies are starting an arms race in content. Six of the biggest entertainment companies, including Netflix (NASDAQ: NFLX), Walt Disney (NYSE: DIS) and Amazon (NASDAQ: AMZN), will spend $27 billion to make or buy shows in 2016, according to a Bloomberg article.

The massive growth in content has led to the term “Peak TV,” which signals an upper limit to the amount of content that can be consumed. 

The Company With the Most to Lose

Netflix alone expects to spend $6 billion on content in 2017, an 20% increase from 2016 spending and roughly double what it spent in 2014. The company has contracted to spend more than $14.4 billion on programming obligations over the next few years, which is more than twice total revenue reported in 2015 and 117 times last year’s net income.

This programming binge is burning cash at an alarming rate. Netflix posted negative $1.2 billion in cash from operations over the past four quarters, depleting $489 million in free cash flow in the third quarter alone. And the company hasn’t generated positive free cash flow since 2013.

Netflix currently has a commanding lead in the United States with 53% of the streaming space, according to Strategy Analytics, followed by Amazon (25%) and Hulu (13%), but competition is sure to heat up as more players vie for a slice of a pie that is growing more slowly. Forty percent of households with a streaming service subscribe to at least two providers, and many new entrants are pricing as low as $5 per month to compete with higher-priced providers like Amazon and Netflix.

Unlike cable services, which lock customers in to long-term contracts, streaming video services like Netflix are susceptible to huge customer losses from quarter to quarter.

For the past two quarters, Netflix has added less than half a million net new U.S. subscribers, which Bloomberg notes is the worst stretch in five years. While subscriber growth was better than expected in Q3, management estimates it will only see 1.45 million net new U.S. subscribers in Q4, 7% fewer than it added during the same period last year.

This would mark the ninth quarter in 11 that saw the company signing up fewer new U.S. subscribers year over year.

Even if the company meets expectations, it may not be enough to support the stock’s valuation. Shares have surged 25% since the company beat Q3 expectations in mid-October and currently trade for about 340 times trailing earnings, the third highest in the S&P 500 after Equinix (NASDAQ: EQIX) and Boston Scientific (NYSE: BSX).

Lest you think I’m a perennial bear on the company, I recommended a bullish trade on Netflix in July that led to a 49% annualized gain. Web streaming services are here to stay, and Netflix will be a big part of that… but investors need to be able to recognize irrational exuberance when they see it.

A lot of the optimism hinges on the company’s international aspirations, as it signed up 3.2 million net new subscribers in the third quarter. However, Netflix provides limited reporting on its international business, and investors may be getting ahead of themselves before it’s proven that international customers, especially those in developing nations, are ready to pay premium fees for programming.

Fourth-quarter earnings are expected to improve 30% and reach $0.13 per share on 35% revenue growth to $2.5 billion. Even if the company meets expectations, I see limited upside in NFLX, and any market weakness could cause shares to fall disproportionately.

When the S&P 500 kicked off 2016 by sliding roughly 11% into its mid-February low, shares of Netflix plummeted 30% during that time as investors fled risky names. 

Netflix is one of my favorite shorts right now, but there is an alternative strategy that could turn a drop in the shares into much larger profits.

How to Make 32% From a 9% Drop in NFLX

Traders can use a simple put option strategy to leverage a downside move in NFLX into much higher returns while also limiting risk to the amount you pay for the option contract (as opposed to theoretically unlimited losses when shorting a stock). If you’d like a crash course on how put options work, watch this six-minute training video.

With NFLX trading for $125.33 at the time of this writing, we can buy a NFLX March 130 Put for about $12.08 per share. That is a put option with a $130 strike price that expires on March 17. Each contract controls 100 shares, costing you $1,208 per contract.

This trade breaks even at $117.92 ($130 strike price minus $12.08 options premium), which is about 6% below the current price.

Any bad news on fourth-quarter earnings or a broader market sell-off could send shares tumbling. My downside target is $114, which is just above the November lows and 9% below the current price.

At this price, our put options would be worth at least $16 per share ($1,600 per contract), which is where traders should place a good ’til cancelled (GTC) order to sell the options. If that target is hit, we’ll book a 32% return in less than three months.

Netflix has a commanding lead in web streaming, but slowing industry growth and increasing competition could make for a bumpy ride over the next year. Investors should watch for opportunities to sell shares short when they surge or utilize the power of options for outsized gains. 

A colleague of mine and former Wall Street insider has been consistently using a simple options strategy to earn 5-10 times as much as regular investors on the same stocks. For a limited time, he’s agreed to let readers in on his tricks of the trade.