Notes on Netflix ($NFLX)

Few examples in the world of business portray ‘I should have seen it coming’ quite like the story of Netflix and Blockbuster. It’s the ultimate example of what happens when you are too big to notice the ground shifting under your feet.

Reed Hastings started Netflix after receiving a $40 late fee for a DVD rental. His business differentiated itself by mailing DVDs to customers - no stores and no late fees! This was 1997. Three years later, Netflix was struggling and offered to sell itself to Blockbuster for $50M. Blockbuster’s CEO rejected the offer, reportedly thinking that Netflix is a niche player that will not scale.

While he wrote off Netflix (and was focused on selling popcorn in Blockbuster stores), Netflix pivoted to streaming movies in 2007. This changed the industry. Barely a decade after rejecting the Netflix deal, Blockbuster declared bankruptcy. Fast forward to 2026, and I think we can safely say Netflix has won the streaming wars. Netflix has the largest paid subscriber base amongst streaming platforms, and its operating margin is 5 times that of its nearest competitor (Disney).

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Netflix’s business model is simple. It licenses and produces world-class video content (TV series, movies, games) and offers subscribers unlimited access to its platform. Some subscription plans include ads (and a lower subscription price), while premium subscriptions do not. Its primary sources of revenue are subscription fees and advertising.

The 3 distinct plans offered in the US are:

The narrative around Netflix has shifted from a growth story in a secularly growing streaming market (over the last 5 years) to a more complex one of increasing competition and consolidation in the media industry (even as the US streaming sector grows at a ~6% CAGR in the coming years).

At the heart of this tension is the proposed merger with Warner Bros. Discovery - a move which signals a pivot from ‘building’ original content to buying legacy libraries. The bears argue this is a defensive move to improve engagement and reduce churn. It saddles the balance sheet with >$50B in debt, effectively ending any capital returns to shareholders in the coming years as Netflix is expected to generate only ~$11B in free cash flow in 2026. There is concern that this deal increases Netflix’s exposure to legacy media, whereas it should be focused on AI-generated and short-form entertainment. On the other hand, the bulls see this as the creation of a ‘super bundle’.

The second factor that the street is worried about is increasing competition. Netflix is facing a two-front war. On one hand, technology giants like Amazon and Apple are spending large amounts to buy live sports and other top-tier franchises (increasing the cost of content). Then there is the proliferation of user-generated content on YouTube, Instagram, and others. This infinite, low-cost content is becoming increasingly popular and has nearly 0 production costs. There is a noticeable shift in consumer preference, with younger users spending more time on user-generated and short video content, and Netflix does not have a product to cater to this changing trend.

Currently, Netflix has more than 325 million paying subscribers worldwide. Its revenue in 2025 was $45.2B, and it generated an operating margin of 29.5%.

It derives most (~76%) of its revenue from the United States and Canada (UCAN) and the EMEA (Europe, Middle East, and Africa) region. These are the regions where customers pay the highest subscription fees per member.

Both the US & Canada and EMEA are mature streaming markets (low subscriber growth), with >80% of US households (similar numbers in Europe) now paying for at least 1 streaming service.

In its most lucrative markets, Netflix is transitioning from a phase of subscriber acquisition to one of retention and monetization, as new user growth becomes increasingly elusive.

Netflix has significantly raised its price over the years. It will be difficult for Netflix to replicate these price increases in the coming decade. With the proliferation of user-generated content powered by AI (Instagram, TikTok, YouTube, etc.), users are spoilt for choice. They may not be willing to keep paying more and more for Netflix’s content (even if it’s the best).

We doubt Netflix can raise prices to $30-$40 per month per subscriber in the coming 5 years (mirroring the increase in the previous 5).

User engagement (hours watched per subscriber per day) has been steadily declining over the years. It is difficult to pinpoint the reason for this - whether this is due to increasing competition, mix change between regions, or if it is due to a lower quality of content on the platform.

Daily engagement - as measured by hours watched per subscriber - has seen a persistent decline. Attributing this trend to a single catalyst is challenging; it likely stems from a confluence of factors, including intensifying competition, regional mix shifts (due to global expansion), and/or reduced content relevance.

The question for investors is: are Netflix’s best days behind it, in terms of user engagement on the platform? And at what cost will Netflix maintain its high user engagement and low churn? Amazon and Apple don’t mind paying very high sums for live events and sports as they can afford it, but if Netflix pays more and more for content while many of its subscribers are simultaneously watching AI-generated content on Instagram (very low cost), then Netflix’s margins will be affected.

There are many issues to consider here, and this is a complicated story. But we see one secular trend - user-generated content will keep increasing. We are not able to judge if Netflix can overcome this challenge - and if so, how? We also estimate that Netflix cannot raise prices more than inflation in the coming years. On top of this, their most profitable markets are already saturated - implying lower subscriber growth.

So, there is higher competition and lower growth on the horizon. And, at a 35x PE ratio (for 10%-15% growth), Netflix is not cheap.

For now, we are placing this in the too-hard bucket. We expect revenue and profits to grow at a 10%-15% CAGR over the next 5 years, but are not comfortable paying 35x earnings. We will revisit the story post-merger or if the stock falls below a 30x PE ratio. We will keep deep diving into the media landscape (Disney is interesting too) and update you as our understanding evolves.

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This work is provided for informational purposes only and should not be construed as legal, business, investment, or tax advice. You should always do your own research