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Indaba's WebTech Research - Video Content Distribution - Netflix, Coinstar


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Indaba's Webtech Research: …

Indaba's Webtech Research:
Netflix & Coinstar Initiation report from 1-18-2012.

Published at a time when NFLX share price was depressed and investors were unsure about what to do with the stock.

Published in: Economy & Finance

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  • 1. Video Content DistributionInvesting in Digital Streaming and DVD Distribution - Jan 18, 2012 - DISTRIBUTED BY
  • 2. DisclaimerThis presentation is confidential and intended solely for distribution by Indaba Global Research (“Indaba”) on behalf ofWebTech Research (“WebTech”). This document may not be reproduced or redistributed without the express permission ofIndaba and WebTech. Recipients of this document agree to treat the document as confidential and agree not to disclose orpermit agents or affiliates to disclose any information contained herein without the express written consent of Indaba andWebTech.This document has been prepared for discussion purposes only and does not constitute an offer for sale of any security.WebTech is not a legal, tax, or accounting adviser and makes no representation as to the accuracy or completeness of any dataor information gathered or prepared by WebTech hereunder. Your company should therefore consult with its own tax,accounting, legal, or other advisers and make its own independent analysis and investigation of any proposed transaction, aswell as the financial and tax consequences thereof, the creditworthiness of the parties involved and all other matters relatingto any transaction, prior to its own independent decision whether or not to enter into any agreements in connection with anytransaction.This document is not intended to provide the sole basis for any evaluation by you of the transaction, security, or instrumentdescribed herein and you agree that the merits or suitability of any such transaction, security, or instrument to your particularsituation will be independently determined by you including consideration of the legal, tax, accounting, regulatory, financial,and other related aspects thereof. Opinions and estimates constitute WebTech’s judgment and are subject to change withoutnotice. In particular, WebTech owes no duty to you (except as required by the rules of the Securities and ExchangeCommission, National Association of Securities Dealers, Financial Services Authority, and/or any other regulatory body havingproper jurisdiction) to exercise any judgment on your behalf as to the merits or suitability of any transaction, security, orinstrument. -2-
  • 3. WebTech Research OverviewWebTech Research produces a research product tailored specifically for investorssearching for an investment edge in emerging web-based technology companies.We are distributed exclusively through Indaba Global Research.We enable clients to:EFFICIENTLY NAVIGATE INVESTMENT OPPORTUNTIES IN WEB-BASED TECHNOLOGY COMPANIES• Concise Communication: Large amounts of data distilled to the most important pieces of information. We don’t write cumbersome 50 page research reports• Actionable Items: Investment ideas with catalysts for realization of our thesis. We know our clients aren’t looking for “holds”INVEST WITH CONFIDENCE• No Conflict of Interest: Our only clients are investment firms. We don’t get in bed with the companies we cover• Buy Side Experience: Our ideas are generated by investors who cut their teeth with hedge fund investment teams and remain active investors -3-
  • 4. Investment Universe + Report FocusOur Universe ofWeb Technology SEARCH MERCHANTS ADVERTISING E-COMMERCE Content MEASUREMENT CONTENT AGENCY / TRAVEL Video DIVERSIFIED GOVERNMENT Music Games POLICY SOFTWARE & IDENTITY SERVICES Traditional Publishers LOCATION CONTENT SERVICES DELIVERY SOCIAL INFRASTRUCTURE DATA PLATFORMS CENTERS Focus of this Report Video Content Distribution Value Chain Studio Content Compatible End Consumers Distributors Devices Warner Bros., Paramount, Fox, Digital: Cable/DBS, Netflix, HBO Digital: PC/tablet/smartphone, Walt Disney / Touchstone, Go, iTunes, Hulu, Amazon Gaming Consoles, TV+Cable/DBS Columbia / TriStar, Universal Physical: Amazon, Wal-Mart Physical: TV + DVD/BlueRay -4-
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  • 6. The Content Flow (chronological order) Medium of Incentive to Release Windows(1) Studio Economics Distribution Studio 1 Theatres/ Tentative Duration: ~80-100% of ticket price (~$7.50) in the first week, 4 Box Office 4-5 Months dropping to ~20% after one month 2 Pay-per-View/ 2-8 Weeks ~60-70% of PPV Price 3 Video on Demand 3 DVD For Purchase: ~20-30% of DVD price($10-$20 for (Purchase, Rental & 6 Weeks standard DVD, $20-$30 for Blue Ray) 1 Streaming) For Rental & Streaming: minimal revenue share 4 Premium Cable Based on film’s box office performance (HBO, Starz, Showtime, 18 Months ($6mm-$8mm per film, up to $25mm for a 2 Cinemax) blockbuster) 5 Free over-the-air cable 12-18 Months $3mm-$15mm per movie 2 (depending on title and the number of runs)_____Source: Canaccord, November 20111) Release windows are prescribed time gaps between which films are aired over different media -6-
  • 7. US Video Rental Market OpportunityInfrastructure improvements will facilitate the growth of digital models, whilecompetitive pricing will drive kiosk growth. NCR Estimates Screen Digest Estimates USD Billion USD Billion 10.0 8.0 9.3 7.4 7.9 6.2 8.0 24.5% 14.0% 6.0 2 2 13.9% 6.0 7.3% 4.0 4.0 12.3% 2.0 2.0 (22.2%) (14.6%) - - 2009 2013F 2010 2015F_____ Brick and Mortar Subscription Digital Kiosk Traditional Subscription KioskSource: NCR, Screen Digest -7-
  • 8. US Streaming OpportunityIncreased broadband penetration – rising from 63.2% in 2010 to 71.0% in 2015 – willcontribute to driving demand for online digital content. 72.0% 71.0% 100.0 70.2% 69.1% 67.6% 68.0% 80.0 65.6% 64.0% 60.0 63.2% 60.0% 60.5% 40.0 56.0% 20.0 52.0% - 2009 2010 2011E 2012E 2013E 2014E 2015E Broadband Subscribers (mm) Broadband Household Penetration_____Source: IDC, December 2011 -8-
  • 9. Worldwide Streaming OpportunityBroadband penetration, combined with improving internet speeds, has helped toestablish internet streaming as the preferred medium for viewing video content. According to Cisco’s Visual Networking Index (VNI) Global IP Traffic Forecast, video traffic is expected to experience ~48% CAGR from 2010-2015, driven increasingly by long-form video content_____Source: Internet World Stats Broadband Presentation -9-
  • 10. Growth of Networked DevicesStrong growth in networked video devices – laptops, tablets, gamingconsoles – is expected to further fuel online streaming of movies/TV shows. U.S. Networked Video Device Installed Base (Units in mm) 200.0 180.0 160.0 140.0 120.0 100.0 80.0 60.0 40.0 20.0 - 2009 2010 2011E 2012E 2013E 2014E_____Source: IDC - 10 -
  • 11. 5 Key Trends • Successful streaming model by NFLX resulted in other technology companies (APPL, GOOG, Growing AMZN) entering the market (primarily through a la carte models) Competition • However, cost advantage remains with incumbent streaming operators such as NFLX, given their focus on older contentStudios Evaluating • Decline in theater attendance (~90% since mid-1970s) and DVD sales (~50-70% of studio revenue) has forced studios to reevaluate existing release window schedulesChanging Release • PPV/VOD/OTT window will offer the biggest opportunity for studios to maximize their Windows profits • As VHS was superseded by DVD, it is expected that DVD will ultimately be superseded by Content Moving digital/streaming models Digital • However, the tail of DVD is TBD • Could prove to be a powerful new subscriber acquisition tool (especially in international Integration with markets)Social Networking • Will facilitate improvements in recommendation engine by employing users’ social data • ISPs – especially those with significant cable distribution businesses, such as Time Warner Internet Service and Comcast – could spoil the party, as they control the pipes which businesses such as Providers? NFLX rely upon • The ability to implement data usage caps will be ultimately decided in the courts - 11 -
  • 12. Competitive Analysis Content Brand Offering Pricing Library Subscribers (mm) Availability • Unlimited Streaming: • Unlimited Streaming - $7.99/month (+$2 for Blu- 20K+ Titles (50% 28-Day delay for Fox, ray) movies, 50% TV Online Streaming + Universal and Warner • DVD-by-mail: $7.99- Shows) 23.8 DVD-by-mail Bros. titles; street date(1) $11.99/month • DVD-by-mail - 125K+ for other studios • Streaming and DVD-by-mail: titles (80% movies, $15.98/month 20% TV Shows) 28-Day delay for Fox, Universal and Warner Automated DVD vending $1.20/night ~200 titles on average to Bros. titles; street date(1) na kiosks for movies & games (Blu-ray – $1.50/night) browse on each kiosk for other studios Free with HBO subscription Available free with HBO (HBO subscription is Within 24 Hours of HBO Subs = 28.2 1400 + HBO Shows subscription ~$10.00/month, incremental to Broadcast HBO Go Subs = na a cable package) Online streaming for Available free with Comcast 75K+ Movies and TV Comcast Subs = 14.0 na Movies and TV Shows Cable TV Subscription Shows xfinity Subs = na Unlimited, commercial- free, streaming-only 12K+ movies and TV $79.00/year na 5.0 offering for Amazon Prime shows members_____Canaccord, November 20111) Street date is the date the movie is to be released for sale to the general public - 12 -
  • 13. Competitive Analysis Content Subscribers Brand Offering Pricing Library Availability (million) • 1.5K seasons of TV Shows (comprising Streaming-only offering $7.99/month 33K+ episodes) na 1.0 for TV Shows • Hundreds of movies and documentaries • $4.99 to $14.99 for DTO movies DTO or VoD for movies • $0.99 to $3.99 for VoD 100K+ movies and TV na na and TV Shows movies Shows • $0.99 to $2.99 for DTO TV shows • $9.99 to $19.99 for DTO movies STO or VoD for movies 50K+ TV Shows, 8K+ • $0.99 to $4.99 for VoD Street date(1) na and TV Shows movies • $0.99 to $1.99 for DTO TV Episodes • 100K+ movies and TV • $10.00 for 1 DVD out at a shows by mail DVD-by-Mail and time • 4K streaming titles to Street date(1) na unlimited streaming • $15.00-$20.00 for multiple computer DVDs out at a time plans • 3K streaming titles to TV • $9.99 for DTO movies DTO or VoD for movies • $3.99 to $4.99 for VoD 30K+ movies and TV Street Date na and TV Episodes movies Shows • $1.99 for DTO TV Episodes_____Canaccord, November 20111) Street date is the date the movie is to be released for sale to the general public - 13 -
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  • 15. Content Distribution Comps Takeaways Key Statistics • Data Availability Company Netflix Coinstar Ticker NFLX CSTR Share Price $94.72 $44.93 o Considering most players in the content Market Cap $5,225.0 $1,387.7 distribution space have diversified business Less: Cash $365.8 $255.3 Plus: Debt $234.7 $397.9 mixes, we have focused on NFLX and CSTR. Enterprise Value $5,093.9 $1,530.3 • Key Metric(s) Revenue 2013E $4,162.3 $2,209.2 o Subscribers / Same-store Sales Growth: Given Y/Y Growth 16.2% 1.8% 2012E $3,582.0 $2,170.2 the intense competition, will the company be Y/Y Growth 12.4% 19.1% LTM $2,924.9 $1,715.7 able to grow subscribers or same-store sales 2013 EV/Sales 1.22x 0.69x 2012 EV/Sales 1.42x 0.71x through attractive pricing and content LTM EV/Sales 1.74x 0.89x acquisition? EBITDA 2013E $395.3 $406.5 • Market Valuation Y/Y Growth 2012E 147.3% $159.9 (2.3%) $416.1 Y/Y Growth (64.7%) 17.6% o Based on 2013E P/E, NFLX trades at a premium LTM $432.6 $341.1 2013 EV/EBITDA 12.9x 3.8x to both the market and CSTR due to position of 2012 EV/EBITDA 31.9x 3.7x LTM EV/EBITDA 11.8x 4.5x strength in online streaming space – the primary long-term growth segment in video EPS 2013E $3.60 $4.01 rental market. CSTR trades at a discount to the Y/Y Growth 370.5% NM 2012E $0.77 $3.92 market due to its reliance on DVD rental kiosks, Y/Y Growth (83.7%) NM LTM $4.40 $2.62 a distribution medium with questionable long- 2013 P/E 26.3x 11.2x 2012 P/E 123.7x 11.5x term prospects (and despite its high margin LTM P/E 21.5x 17.1x coin business). Subscribers / SSS Growth 2013E 28.9% 0.0% (14.4%) 2012E 26.3% 9.5% 7.3%_____Source: Company Filings, Company Press Releases, Bloomberg Estimates and WebTech Research Estimates - 15 -
  • 16. Stock Price and Market Share AnalysisNFLX & CSTR stock performance follows subscriber / same store sales growth. 1/27/10: NFLX Q4 ’09 beat, guidance 2010: NFLX continues to deliver 7/12/11: NFLX separates DVD and 7/25/11: NFLX Q2 ‘11 miss, 10/24/11: NFLX Q3 ‘11 beat, for Q1 & 2011 exceeds expectations strong subscriber growth in ‘10 streaming packages, effectively guidance for Q3 below but subscriber & churn raising prices expectations guidance disappoints 4/29/10: CSTR Q1 ‘10 beat, 350.00 110.0% guidance for Q2 & 2011 1/13/11: CSTR negative 2/3/11: CSTR misses consensus 2/3/11: CSTR misses consensus 2/3/11: CSTR exceeds expectations preannouncement for Q4’ 10 after preannouncement after preannouncement raises DVD rental 100.0% price in response to Durbin related 300.00 90.0% expenses 80.0% 250.00 70.0% Stock Price ($) Market Share 200.00 60.0% 50.0% 150.00 40.0% 30.0% 100.00 20.0% 50.00 10.0% 0.0% - Q2 09 Q3 09 Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 - Netflix - All Other B&M (Includes Local) - NFLX (annotations in top row) Online/By Mail Rental Provider National B&M Rental Chains (Includes .com) All Other B&M (Includes Local) Redbox - National B&M Rental Chains (Includes .com) - Redbox - CSTR (annotations in bottom row)_____Source: NPD VideoWatch data from CSTR’s quarterly filingsNote: National B&M doesn’t include Movie Gallery and Hollywood Video Due to bankruptcy liquidation - 16 -
  • 17. Netflix [NASDAQ: NFLX]NFLX, the market leader in content distribution, saw shares fall ~50% LTM due to a priceincrease and intense competition.KEY SEGMENTS• Online Streaming: Provides access to TV shows and movies streamed over the Internet to TVs, computers and networked devices. Subscribers = ~21.5 million. Priced at $7.99/month. Contribution margin = ~8%• DVD-by-mail: DVDs are sent by US first-class mail and returned using pre-paid mailers. NFLX’s library currently contains over 125K DVD titles. Subscribers = ~13.9 million. Priced at $7.99/month (hybrid plan priced at $15.98/month). Contribution margin = ~50%CONSENSUS CONCERNS• Increasing Content Spend: NFLX announced a marked increase in 2012 content spend (~100% y-o-y) • Our view: We share the concern, and believe NFLX will continue to face rising digital content costs given its focus on streaming. Note that high quality movie content (Sony/Columbia, Warner Bros., Universal, Fox Searchlight etc.) is locked up next few years under current pay TV window and the contract with Starz is ending in Q1 ‘12. We believe that certain studios will continue to limit NFLX’s access to given its value proposition to studios. This coupled with international expansion will impact 2012 profitability• Continued Sub Loss: NFLX lost ~800K subs in Q3 ‘11 due to the increased pricing / Qwikster debacle • Our view: We don’t share this concern – the pricing change was appropriate, but not the way it was communicated. Pricing related sub losses have subsided and NFLX will return to sub growth - 17 -
  • 18. Netflix [CONTINUED]Price Target = $112.77 (19.1% appreciation). Accumulate under $80.69. WHAT WE LIKE • Market Leader: NFLX leads the market with a subscriber base of ~24 million in the US. Given its penetration at ~30% of broadband subscribers and revenue at ~13% of the home video market, Netflix has room for growth. Additionally, NFLX holds a scale advantage not easily replicable without significant investment • Monetization Channel for Catalog Content: Much of the content consumed on NFLX is 1-2 year old catalog content. NFLX’s ability to generate demand for catalog content through its rating system and recommendation engine gives NFLX leverage with studios who are all seeking to monetize older content WEBTECH RESEARCH RECOMMENDATION = BUY under $80.69, aggressively under $77.78 • Price Target: We arrive at a price target of $112.77 based on valuing the earnings potential of the streaming business (we disregard the more profitable, but contracting DVD business in our valuation). We assume NFLX exits 2013 with a streaming ARPU of $8/month, streaming contribution margin of 14.5% (up from 8%) and 34.5mm total subs (up from 25mm). We then tax affect (35% tax rate) the 2013E contribution dollars to arrive at 2013E net income, and apply a 20x P/E multiple (consistent with our view of near-term sub CAGR of 20%) • Price Support: Capital infusions by T.Rowe at $70.00 (equity) and by TCV at $85.80 (zero coupon convertible) will provide support for shares in the event of a pull back • Short: The risk reward ratio for a short trade becomes favorable (at >4.5x) above $107.72. We would consider a fundamental short position if the long-thesis is “over-confirmed” (if shares rise above $124.05) • Stock will move after… a) Q4 earnings (Jan 25th); b) acquisition rumors; c) positive data from and/or further international expansion; d) DVD window extension by other studios - 18 -
  • 19. Coinstar [NASDAQ: CSTR]CSTR, the cheapest DVD rental provider, has plummeted on concerns of the long termviability of DVDs. We believe these concerns are premature. KEY SEGMENTS • DVD Rental (Redbox): Operates 34,400 self-service DVD rental kiosks. Rentals priced at $1.20/night. Contributes ~84% of revenues. Operating Margin = ~18.7%. Market Share = ~34.7% in US DVD rentals • Coin Services: Owns and operates fully automated network of 18,900 self-service coin-counting machines across the US, Canada, Puerto Rico, Ireland and the UK. Charges 9.8 % processing fee. Contributes ~16% of revenues. Operating Margin = ~36.2% CONSENSUS CONCERNS • Impact of Price Hike: In October 2011, Redbox increased daily rental rates from $1.00/night to $1.20/night, citing increased operational costs due to the Durbin agreement • Our view: We do not share this concern as pricing remains competitive relative to other rental options (PPV or VOD). Management guided to incremental $10-$14mm (~3% of Redbox revenues) of expenses on account of the Durbin agreement. The 20% price increase will provide sufficient cushion for additional costs and any loss in rental volumes. We expect our lack of concern to be confirmed when Q4 numbers are released • Lengthening DVD Windows: Recently Warner Bros. doubled DVD window from 28 days to 56 days. While NFLX has agreed to this, both Blockbuster and Redbox are opposing the move • Our view: We share this concern. Without prior agreements, Redbox may have to purchase the DVDs from retail outlets on the street date (first-sale doctrine), which will pressure margins - 19 -
  • 20. Coinstar [CONTINUED]Price Target = $59.31 (32.0% appreciation). Accumulate under $44.08.WHAT WE LIKE• Platform to Launch Streaming Business: Redbox customers rent DVDs from over 30K points of presence (kiosks). Management is taking a captious approach to leveraging its customer base to launch a new streaming business• Low Cost and Geographical Footprint: Capital requirements tend to be low (~$15,000- $20,000 to install a kiosk). Marketing costs are minimal and moreover, ~68% of households are within 5-minute drive-time of a Redbox kiosk• Market Share Gains: VOD prices tend to be $4.99+ for new releases. Until these price points come down, Redbox remains the low price leader for a la carte rentals at $1.20/night. Redbox reported ~20% growth in unique credit cards and ~60% growth in unique email addresses at kiosks in Q3 2011WEBTECH RESEARCH RECOMMENDATION = BUY under $44.00, aggressively under $42.70• Price Target: We arrive at a price target of $59.31 (32.0% upside). Given the distinct margin and growth profiles of CSTR’s two business lines, we assign a 3x EBITDA multiple to the coin business (high margin, but limited growth) and a 6x multiple to the DVD business (prospect of leveraging existing customers if a streaming business is launched). Our EBITDA estimates are based on annualizing the last 9 months for each business segment • Price Support: We recommend closely watching $39.00-$40.00 – a key technical level • Short: The risk reward ratio for a short trade becomes favorable (at >4.5x) above $55.61. We would consider a fundamental short position if the long-thesis is “over-confirmed” (if shares rise above $65.24)• Stock will move after… a) Q4 earnings (Feb 6th); b) announcement of a streaming plan (may include partnership with Verizon); c) DVD window extension by other studios - 20 -
  • 21. For questions and comments, please contact:Brian MurphyIndaba Global DISTRIBUTED BY - 21 -