An Analysis of Netflix's Business
Ishfaque is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While there are a number of ways to analyze a company, perhaps, one of the more robust ways is a SWOT Analysis. This gives a much deeper glimpse of the business in terms of its strengths and weaknesses, which are mostly internal, as well as its opportunities and threats, which are largely external. A good look at Netflix's(NASDAQ: NFLX) SWOT is needed to paint a better picture of the company going forward.
Category Leader: It is the top player and the first mover in the online video streaming space, with more than 30m subscribers. Netflix's subscriber base is significantly higher than its arch rivals in the space, Hulu Plus (32% owned by Walt Disney) which boasts of more than 3m subscribers, and also Amazon (NASDAQ: AMZN) Prime which doesn't disclose the number of subscribers, but is estimated to have between 3m to 7m subscribers.
Content Collection: It has perhaps the biggest collection of professional and premium content amongst all the streaming companies. And it is making strong content deals and built a strong relationship with Media Powerhouse, Walt Disney (NYSE: DIS). Content from Disney should reasonably bring in a lot of new subscribers, and also increase movie content consumption, as TV Content consumption makes up a majority of total streaming.
Price Point & Recurring Revenue Model: A broader appeal of Netflix to the masses is the low price point that it comes with. This makes it very attractive and appealing to a lot of consumers, and many are indifferent towards cancelling a subscription, even when they don't use the service frequently i.e. limits the churn rate (voluntary cancellations only). The end result is a recurring revenue stream, which is a strong thumbs up for any business, not only Netflix.
Becoming Ubiquitous: Netflix is increasingly becoming more ubiquitous and can be viewed from almost anywhere with an Internet connection. It is available in all sorts of mobile devices, tablets, gaming consoles such as XBox, Wii, Playstation etc. This is a strong value proposition of Netflix, which appeals to a broad customer base.
Brand Name: Netflix has managed to build up a strong brand name across the U.S. and its brand value is helping it gain more subscribers in International Markets.
Price Sensitivity: Customers are very price sensitive in the online video streaming space, as can be seen from the subscription cancellations in Q3 2011. This is not only a concern for the near term, this is going to be a problem in the long run, as Netflix would find it hard to push price increases to the end consumer. And the entry of big cash rich competitors such as Google, Amazon won't help either, effectively giving Netflix minimal pricing power in the near term.
Business Model Weakness: The Netflix business model works by adding substantial amounts of premium content, pricey marketing campaigns, and then subscribers tune in. This cycle has worked out for Netflix so far, but if subscribers jump ship in large numbers, it can pose material threats to Netflix's business due to substantial amounts of cash outlays, before revenues come in, and these capital expenditures are funded with large amounts of debt.
International operations require heavy capital expenditures before Netflix can generate subscribers and sales. As a result, it is losing money in a number of countries. It has made progress in a number of places, but losses from these avenues are putting a drain on its Free Cash Flow and Net Income, and would likely continue in the near term.
Decline in DVD Business: The exodus of customers from Netflix's DVD segment has been quite strong, and is very likely, a structural change in media consumption by customers. The higher margin DVD Business lost ~2.6m subscribers Year-to-date. The likes of Wal-Mart's (NYSE: WMT) VUDU, Coinstar's (NASDAQ: OUTR) Redbox, YouTube, etc. are likely getting more traction for the Video on Demand (VOD) market.
Traction in Premium TV Space: By making a deal with Disney, Netflix is in effect, making its way into the ballpark of the premium TV Channels. And it can snatch subscribers from channels like HBO Go and Liberty Media's Starz, as it will get the first chance to show movies that are barely 6-8 months old, but that is not going to take place before late 2016. Also, Netflix is getting customers who don't want to use the pricey pay-as-you-go model for Video on Demand.
Produce More Original Content: One of the best ways for Netflix to hold on to its existing customers tightly and attract newer one would be to produce more original content by itself. Amazon has built up a platform to do so, and is even going to crowdsource the series selection process, by letting subscribers vote on which Pilots to continue.
Expansion across more countries and provide more content across the world. Improved internet connections and steadily improving online payments would provide additional tailwind to gain more subscribers for Netflix especially in Latin America and Europe.
Intense Competition: Many alternative choices from competitors with respect to streaming, DVDs and Video on Demand such as Redbox, Hulu, Google, Amazon, Walmart's VUDU are available even though their content collection isn't necessarily comparable.
Content Acquisition Costs are on the rise, and Netflix is battling it out hard for content with Amazon, and bidding up content prices, along with content providers asking for more. This rise in content prices coupled with international expansion is prompting Netflix to take on more and more debt, and its debt got downgraded recently by Moody's.
There seems to be a mixed bag of positives and negatives for Netflix at the moment, it is making progress by adding more content, but the competition is heating up. Valuation looks full, and it is not expected to roll out a sizable net income and Free Cashflow will be negative for at least the next few quarters. With a decent run up for the stock, a wait-and-watch approach for Netflix sounds about right.
ishfaque has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Walt Disney, and Netflix. Motley Fool newsletter services recommend Amazon.com, Walt Disney, and Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!