By “it” I am not solely referring to Netflix (NASDAQ: NFLX) earnings report–that’s part of it. What I mean more specifically is that Netflix has once again destroyed market expectations as to the company’s growth and outlook. And yet still, despite the company’s performance on the earnings front, people continue to question the stock’s performance. Let’s just set the record straight for a second: Netflix is way more than “just” a video rental company, they are THE premiere media company in the emerging digital domain. In this particular write up, I will purposely glance over the company’s latest earnings report in order to hone in on what really is going on when it comes to the stock that is Netflix.
The first time I wrote about the company for the WSCS came following a Wall Street Journal article that asked whether “Netflix is the next Crocs?” In my response to that article, I laid out the basics of the Netflix story in order to counter the assertion that Netflix was merely a “fad” in a passing trend. The essence of the Crocs assertion relied on Netflix merely being a new-age Blockbuster clone with a mainstream trendiness translated into equity market success. The cynicism against Netflix success has reached such proportions that sites like Zerohedge fully attribute the stock’s ascent to the Fed’s open market operations. Many simply cannot fathom that people and institutions want to own this company to the point where 23% of the float is short!
In some ways there is more at work than just the fact that people doubt Netflix as a company. These days, anything that goes up in value in rapid fashion is dubbed a “bubble.” It need not be an irrational rise, simply a quick ascent evokes the bubble conversation. Add that to the fact that many maintain the belief that our economy is heading for a cataclysmic collapse and you can already get a sense as to why the Zerohedgies in particular like shorting this stock.
In the company’s earnings release yesterday after the bell, we learned that its subscriber base grew 52% year-over-year and that 66% of its subscribers watched streaming video during the past quarter. These are the two trends that are really worth watching with the company. On the one hand is the fact that subscriber growth has reached its tipping point whereby many people realize that they just have to have access to Netflix, as evidenced by the dramatic drop in cost-per-acquisition from $24.37 in the 2nd quarter to $19.81 in the latest report and the continued fall in the churn rate from 4.4% a year ago to just 3.81% in the last quarter (Source: Barron’s Tech Trader Daily). And on the other hand is the fact that streaming media from Netflix has gotten so incredibly easy.
Anecdotal evidence often provides a clear picture of exactly what’s going on. Just last month I personally received a “friends and family” offer to send out to my own friends. I know eight individual people who took my invitation and decided the time is finally right to join. The precise catalysts for joining varied; however, the predominant factor has been both the growth in Netflix’ streaming catalog, and the ease with which one can now access that database. Of important note is that the rise in Netflix popularity–and of the streaming service in particular–has expanded beyond just the tech savvy Generation Y-ers. Both my parents and in-laws now have Netflix accounts and Roku boxes through which to stream online content. They are not your typical techies who look for the latest “thing” to use. Within their age group there are many who are frequent Netflixers and who use that service in lieu of other “on demand” or rental options.
What Netflix now has is a company that people need to be a part of in order to complement and complete their media access. There is simply no other company that has what Netflix provides. In essence, it has built a gigantic moat around its service offering. Just recently, Amazon (NASDAQ: AMZN) had been trying aggressively to build a competing service; however, they realized that the capital outlay required to achieve what Netflix already has would be far too great. The recent 5 year, $1 billion deal for streaming rights to Paramount, Lions Gate and MGM films is a major coup for this young company that will be difficult for any competitor, whether established or not, to compete. What this all means is that the business that Netflix has built already enjoys a substantial intrinsic value. Add to that dramatic subscriber and earnings growth and you get the picture: a stock that just keeps going up.
Now let’s dig into that stock price a little. First let’s think about a comparable publicly traded company. In many respects, I believe that to be Amazon–a web-based retailer and media company that also sells video and audio content online. Amazon boasts a market cap of $73 billion, trades with a P/E of 67, a forward P/E of 45 and a PEG of 2.38. Netflix has a market cap of $8.9 billion, a trailing P/E of 69, a forward P/E of 45 and a PEG of 2.02 (these ratios are post-earnings rally). These are remarkably similar metrics on the ratios, yet the market cap raises an important point. The law of large numbers asserts that it is far harder to grow a large company to be even larger than it is to grow a small company. I think in part due to the rapid ascent in Netflix shareprice, people have somewhat forgotten that this is still a relatively small company that has yet to penetrate its potential market to nearly the full extent possible. Moreover, it is a company far from the maturation point with ample room to both grow and develop its value proposition to subscribers. Considering the growth, the size of the company, and the potential for yet more, this stock deserves some considerable multiple expansion.
Update: Go figure that within minutes of writing about the web-based success of Netflix that the site itself actually goes down. Well you know what? While it may matter for a day or two, it does very little to actually change the longer-term story. Many economists have been talking about the benefits of financial decisions being made in a slower manner, with the benefit of time to digest news. One example of this might be the contrast between the reaction to the outages at Netflix and Facebook.
When Facebook went down towards the end of September, many people were left needlessly bored at work; however, there was no commentary from the financial community and there certainly was no drop in Facebook’s enterprise value. No one really questioned the long-term prospects of Facebook because it didn’t really matter outside the world (i.e. the stock market) where only the shortest-term really matters. Meanwhile, Netflix goes down for a day and the naysayers swarm on the attack. Let’s just put this all into context for a second: Netflix went down for a day and that sucked for just about anyone looking to watch a movie or add one to their queue at that time. Netflix is once again back up and running and the company still remains THE premiere media company in the digital arena. Let’s just leave it at that.
Disclosure: Long NFLX