Netflix, Inc. (NASDAQ:NFLX)
CAPS Rating:
Netflix delivers its comprehensive library of movies and TV shows online and through the mail in their ubiquitous red envelopes.
The World's Greatest Investing Community
Netflix delivers its comprehensive library of movies and TV shows online and through the mail in their ubiquitous red envelopes.
BATS data provided in real-time. NYSE, NASDAQ and AMEX data delayed 15 minutes.
Real-Time prices provided by BATS. Market data provided by Interactive Data.
Company fundamental data provided by Morningstar. Earnings Estimates and Analyst Ratings provided by Zacks.
SEC Filings and Insider Transactions provided by Edgar Online.
Powered and implemented by Interactive Data Managed Solutions. Terms & Conditions
RSS Headlines
Fool UK
Recs
I won't go into why Reed Hastings is a visionary CEO or why Netflix has a great product. I think even naysayers would agree to these points.
What I do hear is people arguing NFLX is overpriced; their glory days are behind them and while they dominated the economies of scale within their DVD by mail business, their online streaming business doesn't follow the same path.
I don't believe this is true and would argue there are SIGNIFICANT barriers to entry to the streaming business. In order of complexity/difficulty to overcome:
1) The major studios and networks hate the trend to streaming consumption. HATE. IT. It has destroyed their single most profitable revenue windows - DVD sales and cable subscriptions. That said, the writing on the wall is crystal clear at this point - consumers are demanding it and they'll gin up reasonably complicated tech workarounds to get it. The studios and networks know they have to play ball, and right now Netflix has a massive head start on the tricky and trying negotiations with the big license holders. Those rights holders don't like outsiders and it's taken Netflix a VERY long time just to get a seat at the kids table in their club. No other outsider is going to get in easily, if at all. So, why don't the studios and networks just get together and form their own streaming business? Well, they are direct competitors and getting in bed with each other is unnatural. Now, to some degree of success they have done so with Hulu, but not all the networks and cable providers have signed on. What more - they aren't making enough money. They can't get an advertising based model to work online, and the subscription service hasn't really caught on. As for movie studios, the biggest group was EPIX, a joint venture between Viacom, MGM and Lionsgate. On a shockingly fast timeline, EPIX signed the biggest licensing agreement in Netflix's history, giving them semi-exclusive window to stream 3,500+ late release films. This was a MASSIVE win for Netflix, and proves the studios are not interested in, or unable to, replicate Netflix's distribution model.
2) You need a lot of hardware partners to do this effectively. A web browser and a smartphone application is just not going to cut it. You need access to the most entrenched set top boxes in order to really argue an attractive value proposition to consumers. Netflix owns the Playstation 3, Xbox 360, Wii, Apple TV, TiVo, Roku, scores of Blu-Ray players and TV manufacturers. In short, they've negotiated prime real estate on via an OEM to software model that these hardware creators will not give to other parties - the space is too valuable.
3) Their algorithm. Netflix lives and dies by their online recommendation engine. powered by their famous algorithmic method of deciding. The company cares so much about this piece of their puzzle they hosted a yearly competition in which budding quants could win up to $1MM for improving their algorithm just a few percentage points. What other online companies come to mind when one thinks about reliance on algorithmic recommendations - Google and Amazon. Pretty good company if you ask me. Again, due to their dominance of input (lots of users) and mathematical tinkering, this will be a challenging advantage to overcome.
4) Consumer loyalty. Yes, it's fickle and yes it can be bought, but Netflix has an extremely populist brand. They are "of the people" and "sticking it to the man". They have a trademark on the word "queue" and people are literally starting to ask for "Netflix recommendations" rather than "movie recommendations." People have put a lot of effort into ranking, rating and otherwise fleshing out their online Netflix profiles - they will be reticent to do all this over again with another partner.
For these reasons I believe Netflix will be the online streaming media market leader of the future, and even a cursory glance at market sentiments reveals online streaming WILL BE the choice method of consumption in the decades to come.
Disclosure: I own a long position in Netflix and while I am not directly involved in this market, I work in digital media and am familiar with the parties involved.
Thank you for the excellent write-up.
I am still trying to get a better understanding of the market structure that Netflix operates in, its business model, and its' competitors. What I am still struggling to understand is why don't cable companies offer a subscription based service offering to customers similar to Netflix? Is there anything preventing them from delivering on-demand or streaming content to consumers or is something making it unattractive in order to compete with Netflix? Cable companies already have the valuable real-estate mentioned in #2 with the cable box sitting in my living room. Why can't they just change the fee structure of their services, sign a few content contracts with content owners, and start competing with Netflix?
Point 2 is where the change will be happening. Streaming video to portable devices is coming, undoubtedly. Netflix will prosper, cable tv will suffer.
Cable companies can duplicate the Netflix service, but they don't have the economies of scale that Netflix has (nationwide distribution to tens of millions of customers.) The cost of the hardware, software, content, and maintenance has to be spread out over a much smaller customer base. And duplicating the delivery service leaves the customer without Netflix's suggestions, reviews, and DVD-by-mail options. At best, they can give you a lame simulation of the service -- at a higher cost, or else without a profit.
Netflix delivers over two mediums - cable and mail:
Cable is paid for by the cable company, who pays for the infrastructure
Mail is paid for by USPS which is subsidized
The point is, Netflix piggy-backs on other company's mediums - it's a great concept, but how long will it be til these companies start demanding a piece of the profit? Cox cable, which I use, already offers streaming movies, and yes, I definitely use it instead of Netflix. But I don't live in a rural area. If Netflix can secure some kind of patent that gives them exclusive distribution rights over all the movies they have, then they are a sure bet. But, if cable lobbies and wrestles back the right to control bandwidth and charge for usage, Netflix will lose its advantage. All of this is to say, Netflix is walking a tight rope right now, and I don't think it will be able to stand up against all of the other bigger players in the game. And yes, I am short NFLX
This is a reasonable pitch. Your points 2, 3, and 4 are reasonable attempts to argue that NFLX has a durable competitive advantage. They sound to me a lot like arguments that I've heard before in other places. For instance, with regard to points 2 and 3, there is no way that a small upstart company founded by kids from Stanford - academics! With PhDs! - could compete with the entrenched monolith of search that is known as AltaVista. The hardware, bandwidth, and software requirements are too great. Similarly, it is not reasonable to think that a company with no experience building a phone or partnering with telecom companies could ever make a dent in the smartphone market, especially as their background is computers, user interface and online music sales! And with regard to #4, I would be very skeptical about a company like Facebook, especially given Myspace and Orkut's considerable installed base. All those arguments were wrong. Technology has a way of taking today's durable competitive advantage and turning it into tomorrow's compost heap. There are sharks circling in the water around NFLX - hundreds of players wanting them to lose market share, including all their direct competitors and all their content-providing clients. I'd rather own something with a real competitive advantage, like an aggregate pit.