The Bull vs. Bear Case for Netflix

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Read the whole story here: http://mot.ly/13uO1LB -- With the stock price now around $100 per share, some investors are hoping that Netflix can return to its former glory. Others believe Netflix is playing a losing hand, and will never achieve the profitability it once enjoyed.

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The Bull vs. Bear Case for Netflix

  1. 1. The Bull Case for NetflixPhoto: istockphoto.com
  2. 2. • Management has proved its vision and adaptability.• Superior technology with a huge database of viewing histories and preferences.• Improving content selection with an emphasis on exclusivity.• A compelling model that appears to be working.• Creating a niche with children’s programming.• Brand still has tremendous power.
  3. 3. Management has proved its vision and adaptability.“I believe that he is thesmartest guy in theroom of his ownindustry – and it is aHUGE industry.”-- David Gardner, co-founder, The Motley Fool, onReed Hastings, CEO, Netflix
  4. 4. Management has proved its vision and adaptability.In 1998, management disrupted the VHS business with its DVD delivery model. By 2010, its DVD-by-mail business drove $2 billion in sales. Its DVD library is now the world’s largest with more than 200,000 titles.
  5. 5. Management has proved its vision and adaptability. Management envisioned “digital delivery” in 1999, and launched streaming in 2007.It’s now the world’s largest Internet movie subscription service.
  6. 6. Management has proved its vision and adaptability. Management powered ahead withinternational expansion even thoughdomestic streaming was still thriving.• Canada• Latin America• UK and Ireland• Sweden, Denmark, Norway, Finland
  7. 7. • Management has proved its vision and adaptability.• Superior technology with a huge database of viewing histories and preferences.• Improving content selection with an emphasis on exclusivity.• A compelling model that appears to be working.• Creating a niche with children’s programming.• Brand still has tremendous power.
  8. 8. Superior technology with a huge database of viewing histories and preferences. “The Netflix website is essentially a highly instrumented market researchplatform that has allowed the companyto track, analyze and project consumer behavior around entertainment consumption for 15 years.” -- Gina Keating, author of Netflixed
  9. 9. Superior technology with a huge database of viewing histories and preferences.• As of June 2012, it had more than 25 million users.• About 30 million plays per day.• 4 million ratings per day.• 3 million searches per day.• More than 2 billion hours of streaming video watched during last 3 months of 2011. Source: http://gigaom.com/2012/06/14/netflix-analyzes-a-lot-of-data-about-your-viewing-habits/
  10. 10. Superior technology with a huge database of viewing histories and preferences.75% of Netflix’s customers select movies based on the company’s recommendations. Netflix aims to increase that number.
  11. 11. Superior technology with a huge database of viewing histories and preferences.Netflix’s Asgard streaming technology is considered the best in the business.Asgard is a web interface for application deployments and cloud management.
  12. 12. • Management has proved its vision and adaptability.• Superior technology with a huge database of viewing histories and preferences.• Improving content selection with an emphasis on exclusivity.• A compelling model that appears to be working.• Creating a niche with children’s programming.• Brand still has tremendous power.
  13. 13. Improving content selection with an emphasis on exclusivity.Netflix maintains a DVD library of more than 200,000 titles for its subscribers.
  14. 14. Improving content selection with an emphasis on exclusivity.Has the most streaming titles 60,000 (est.)
  15. 15. Improving content selection with an emphasis on exclusivity. The recent deal with Disneydramatically improves its content selection going forward.
  16. 16. • Management has proved its vision and adaptability.• Superior technology with a huge database of viewing histories and preferences.• Improving content selection with an emphasis on exclusivity.• A compelling model that appears to be working.• Creating a niche with children’s programming.• Brand still has tremendous power.
  17. 17. A compelling model that appears to be working. It is the unseen aspects of Netflix’s business model, and its long headstart, which differentiate it from the competition… -- Mario Cibelli, Marathon Partners
  18. 18. A compelling model that appears to be working.In FY 2012, domestic subscriptions expected to grow 23%.
  19. 19. A compelling model that appears to be working. So, a marginal streaming subscriber is almost pure contribution margin. There is a little bit for credit card, CS, and CD end fees, but it is pretty modest. A marginal DVD subscriber has a number of variable costs -- the postage and DVD fees, in particular.So, actually it is the opposite, which is the profitability of a new streaming subscriber, the contribution margin is almost twice what it is for a DVD subscriber.-- Ellie Mertz, CFO, Netflix, on streaming subscribers
  20. 20. A compelling model that appears to be working. The more subs, the more contentNetflix can buy, attracting more subs.
  21. 21. A compelling model that appears to be working. Since it introduced streaming in2007, acquisition cost/sub dropped from $40.86 to $15.04 in 2011.
  22. 22. • Management has proved its vision and adaptability.• Superior technology with a huge database of viewing histories and preferences.• Improving content selection with an emphasis on exclusivity.• A compelling model that appears to be working.• Creating a niche with children’s programming.• Brand still has tremendous power.
  23. 23. Creating a niche with children’s programming.Netflix found the most popular Starz content was animated.
  24. 24. Creating a niche with children’s programming.Kids now have own profiles with history, ratings, queues and recommendations.
  25. 25. Creating a niche with children’s programming.Access to Disney library will increase attractiveness vs. competitors.
  26. 26. • Management has proved its vision and adaptability.• Superior technology with a huge database of viewing histories and preferences.• Improving content selection with an emphasis on exclusivity.• A compelling model that appears to be working.• Creating a niche with children’s programming.• Brand still has tremendous power.
  27. 27. Brand still has tremendous power.Netflixs 2010 entry into Canada wassuccessful and is already profitable.
  28. 28. Brand still has tremendous power.Entered UK and Ireland in Jan. 2012 andgained 1 million subs in just 7 months.
  29. 29. The Bear Case for NetflixPhoto: istockphoto.com
  30. 30. • Netflix’s customers are very price sensitive.• Streaming will never be as profitable as DVDs.• Netflix’s financials are weakening.• International expansion poses enormous challenges.• Revenue growth not keeping up with content costs.• Other threats to streaming.
  31. 31. Netflix’s customers are very price sensitive.Netflix’s price hike in the 3rd quarter of 2011 resulted in 805,000 paid subscribers jumping ship.Netflix’s share price
  32. 32. Netflix’s customers are very price sensitive. If Netflix raises streamingprices, it’ll lose customers. That makes it difficult to pay for content.
  33. 33. Netflix’s customers are very price sensitive. Date Old Price New Price Churn Churn This Churn Reaction Std. 3 DVD Std. 3 DVD Previous Qtr. Subsequent Plan Plan Qtr. Qtr.6/15/04 $19.95 $21.99 4.7 5.6 5.6 Blockbuster mail service began 8/04. Lowered price to $17.99 effective Nov. 1.6/30/05 $17.99 $17.99 5.0 4.7 4.3 Introduced lower price options.9/30/06 $17.99 $17.99 4.3 4.2 3.9 Churn in Q2 dropped from 4.7% yr. ago due to price parity and less aggressive competition from Blockbuster.3/31/07 $17.99 $17.99 3.9 4.4 4.6 Up from 4.1% yr. ago. Lowered price of entry plan from $5.99 to $4.99 in Q1 2007. Increase in churn in Q2 2007 attributed to increased competition.7/22/07 $17.99 $16.99 4.4 4.6 4.3 Dropped price on two most popular plans.9/30/10 $16.99 $16.99 4.0 3.8 3.7 Low churn prompts price hike in November.11/22/10 $16.99 $19.99 3.8 3.7 3.9 Introduced unlimited streaming only for $7.99. Raised prices on 1 and 2 DVDs $1 to $9.99 and $14.99.3/31/11 $19.99 $19.99 3.7 3.9 4.27/12/11 $19.99 $23.98 4.2 6.3 4.9 Unbundled DVD and streaming, charging $15.98 for 1 DVD + unlimited streaming9/30/11 $19.99 $23.98 4.2 6.3 4.9 Lost 11.3% of domestic subs in Q3 2011. Churn in Q3 2010 was 3.8%.2012 $19.99 $23.98 4.9 Stopped talking about churn. No longer a key metric?
  34. 34. • Netflix’s customers are very price sensitive.• Streaming will never be as profitable as DVDs.• Netflix’s financials are weakening.• International expansion poses enormous challenges.• Revenue growth not keeping up with content costs.• Other threats to streaming.
  35. 35. Streaming will never be as profitable as DVDs.Comparing profit contribution for first 4 quarters after it turned positive for DVDs vs. first 4 quarters for streaming shows DVDs more profitable.
  36. 36. Streaming will never be as profitable as DVDs.To equal DVD profit, monthly price for streaming would have to more than double to $17.60.
  37. 37. Streaming will never be as profitable as DVDs.Alternatively, Netflix would need 30 million more subs.
  38. 38. Streaming will never be as profitable as DVDs.Streaming will never reach peakDVD Profit Contribution per sub of $26.19 in 2004.
  39. 39. • Netflix’s customers are very price sensitive.• Streaming will never be as profitable as DVDs.• Netflix’s financials are weakening.• International expansion poses enormous challenges.• Revenue growth not keeping up with content costs.• Other threats to streaming.
  40. 40. Netflix’s financials are weakening.Quick ratio hasbeendeclining, but washelped somewhatby convertiblebond issued inNov. 2011.
  41. 41. Netflix’s financials are weakening.TTM cash flow from operations has decreased in each of the last 4 quarters.
  42. 42. Netflix’s financials are weakening.TTM free cash flow plunged in Q3 2012 due to slowing growth and increasing content costs to support international expansion.
  43. 43. • Netflix’s customers are very price sensitive.• Streaming will never be as profitable as DVDs.• Netflix’s financials are weakening.• International expansion poses enormous challenges.• Revenue growth not keeping up with content costs.• Other threats to streaming.
  44. 44. International expansion poses enormous challenges. Q1 2012 Letter to Shareholders:"Latin America presents unique challenges relative to our othermarkets; namely, low device penetration, high piracy, varyingpreferences for subtitles, and relatively low credit card usagefor ecommerce. We are quickly learning what content worksbest in the region, and are adjusting our content libraryaccordingly. We have already nearly doubled our content librarysince launch... Finally, as expected upon launch, we’ve foundthat processing ecommerce consumer payments is quitechallenging as compared with North America and Europe.”
  45. 45. International expansion poses enormous challenges. Q1 2011 Letter to Shareholders:"We are still learning the seasonality curveand nuances specific toCanada, however, and we slightly over-forecast the quarter."
  46. 46. • Netflix’s customers are very price sensitive.• Streaming will never be as profitable as DVDs.• Netflix’s financials are weakening.• International expansion poses enormous challenges.• Revenue growth not keeping up with content costs.• Other threats to streaming.
  47. 47. Revenue growth not keeping upwith content costs.
  48. 48. • Netflix’s customers are very price sensitive.• Streaming will never be as profitable as DVDs.• Netflix’s financials are weakening.• International expansion poses enormous challenges.• Revenue growth not keeping up with content costs.• Other threats to streaming.
  49. 49. Other threats to streaming.• Increasing domestic competition from Hulu Plus, Amazon Prime and Redbox/Verizon.• Carlos Slims launch of Clarovideo in Mexico and other Latin American countries for $5/month undercutting Netflix by 37%. Collection simplified by adding to phone bill.• HBOs coming entry in Scandinavia.• Data caps imposed by broadband providers.
  50. 50. • Superior technology is a real advantage.• Deal with Disney is a big step in the right direction and shows Disneys confidence in Netflixs future.• It’ll be very challenging to grow sales enough to cover content investments needed to attract customers.
  51. 51. • Current inability to raise prices without losing subs hinders sales growth.• Lack of affordable access to broadband and data caps may slow growth.• Keep an eye on the rates of domestic and international streaming sub growth.

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