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Optimism for Netflix

Posted in Trading

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Introduction

Back in January, I’ve written about the pessimism in investing in Netflix (NFLX). Although there have been bigger buyouts in the past, I do not believe that NFLX can be a target for a buyout by another company. Many have speculated that Disney can be a potential suitor. There are probably many other speculative suitors, including some tech giants with very large cash reserves. However, my thoughts are the opposite. There is a lot of potential for Netflix to progress to the next level even in the midst of adverse conditions.

Only the Paranoid Survive

Netflix has many competitors in the entertainment space. Besides the major television networks, there are hundreds of cable channels. These channels are provided by many multichannel video programming distributors (MVPDs). These MVPDs can be wired or wireless. Competition is fierce.

The main competitor is Amazon Video. Amazon is a much bigger company, but video represents are smaller portion of Amazon’s revenue. It is harder to compare the financials because content is available to Amazon Prime members, combined with other free benefits. Amazon has an advantage by being able to throw large sums of money on content. To compete, Netflix continually provides more original content. Winning many awards every year, its content draws more subscribers. Recently, YouTube has announced streaming channels to be available in the near future. Now, DirecTV no longer requires a satellite dish to subscribe to its streaming channels. It can be streamed through an app in Apple TV box or other streaming set-top boxes. Yahoo and Twitter have live-streamed NFL games. Facebook is inking deals to live-stream sporting events. Competition is getting more fierce.

Dominance of Netflix

Netflix has over 100 million subscribers worldwide. As Netflix adds more subscribers every quarter, the cable companies are losing viewers. As “cord-cutting” becomes more popular, broadband is more important than having hundreds of channels. Also, during peak times, Netflix consumers use more than 33% of the overall broadband usage. The close second is YouTube, and a distant third is Amazon Video. Netflix is willing to spend a lot of its cash for content. Amazon Video has a similar strategy, where both companies have made waves at Sundance Film Festivals. Distribution deals for content are more competitive and have higher contract prices, due to these companies. Netflix has an intuitive user interface, which seems easier than any other platform.

Netflix made significant deals with Disney. Besides producing original Marvel Universe content, they have signed a production deal with the most popular star in India. Bollywood produces more movies per year than Hollywood. Even though the overall revenue market is smaller, there are more audiences in India, 3 times more.

Netflix is able to pivot its business model fairly quickly. It started out as a DVD distribution company, mailing DVD rentals through the mail. Hindsight has proven that Blockbuster Video made a mistake by not buying Netflix for $50 million dollars. However, I am not sure if Netflix would have developed into the company today if it was under Blockbuster. Afterwards, Netflix identified streaming as the future and invested in streaming technology. Now, I believe Netflix has pivoted to add content as a key component in its business strategy.

Future of Netflix

Here’s where I think Netflix is headed. This is pure speculation, but it is fun to imagine what Netflix can do.

  • Netflix will not be bought out by Disney. The market capitalization of Disney is $170B with $55B in revenues. The market capitalization of Netflix is $60B with revenues of $9B. In order to buy Netflix, a premium must be offered. Even at market cap, Netflix will be expensive to just add about 16% increased revenue.
  • I think Netflix will pivot from just distributing online video content. They have been experimenting with weekly shows. Whatever the data shows, Netflix will adjust their content according to their viewers. The technology is there that Netflix is able to even provide live-stream content.
  • Young viewers are absorbing enormous amount of video content. They will continue to invest heavily for younger viewers. I expect Netflix to break out content to various age groups or video content ratings. Instead of just a kids level, content can be divided by appropriate age groups. I see one and half year old children grabbing smartphones and operating them with dexterity to watch shows like Peppa Pig.
  • I expect Netflix to make a deal with Disney to distribute live content. ESPN, a subsidiary of Disney, is losing viewers. Therefore, ESPN can easily gain millions of viewers instantly, by streaming its shows through the Netflix platform. Majority of my friends have cable in order to not just watch sports, but to watch ESPN news about sports. Watching the highlights and commentary is part of their daily ritual. If Netflix starts distributing those shows, both companies benefit. Another reason for many to cord-cut from subscription television.
  • Netflix will pivot to provide an ad model on some shows. Cable television was mainly funded by subscribers in the 80’s, but the channels soon went to an advertisement model. Cable subscribers still have to pay fees for the channels, but now they have to see ads. Consumers are conditioned to see advertisements, before, during, and after the show. Some people watch the yearly NFL Super Bowl for the commercials, not the actual game. This may become another service or platform, added on top of the current subscription.

Whatever the direction Netflix takes, I hope it will be an interesting one.

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