Netflix is No Crocs

Netflix (NASDAQ: NFLX) missed their revenue expectation, while crushing their earnings per share number and suddenly the Wall Street Journal asks  “Is Netflix the Next Crocs (NASDAQ: CROX)?”  Although the WSJ did not conclude that Netflix=Crocs, the suggestion alone is so absurd that I feel compelled to offer a response.

The Crocs Fad

For those who don’t remember, Crocs makes one kind of shoe–the “Crocs”–and is the owner of the “Croslite” patent on their own variety of lightweight rubber.  While the company has tried to tinker with its line of products by offering colorful varieties and incorporating some twists to it’s sandal variety, by and large, Crocs is a one-hit wonder in the consumer marketplace.  In 2006 the shoes started gaining in popularity and in 2007 the trend went viral.  Everyone from toddlers to retirees sported the shoes on the beach, at the pool and even at the office.A rainbow of Crocs attempts to draw the eye of consumers.

In 2007, earnings peaked out at $168 million and as the trend went viral, the stock went parabolic.  As the stock flew, the company took on more debt (albeit modestly so) in order to pursue an aggressive expansion of the Crocs retail presence and in an attempt to create another hit with consumers.  In its peak year, Crocs boasted a market capitalization of $4.45 billion.  Crocs’ 2008 revenues came in 15% below 2007 and the company lost another 11% of its revenues in 2009, while their operating expenses were on the rise.

Through it all, Crocs enjoyed three years of profitability and one year of solid earnings. The company’s shoes are still a popular product with some subsets of the consumer base; however, they were a trendy fad product which even the biggest enthusiast could only wear on a limited number of days each year.  As can be expected, the product reached its maximum point of saturation and now is merely a niche offering amidst a host of alternative footwear.

Netflix Builds a Long Term Vision

Netflix delivers to its subscribers and shareholders.

Yesterday in my Netflix earnings recap, I highlighted the company’s steady margin expansion on account of increasing subscriber use of Netflix’ rapidly expanding streaming library.  Netflix invested heavily in building out a capital intensive business, with a loyal and growing subscriber base.  Unlike shoes, which people buy, wear and discard based on their fashion whims of the moment, Netflix subscribers demonstrate a high degree of loyalty and the company reciprocates by continually improving the quality and quantity of titles in their service.

Unlike Crocs, Netflix’ revenues from 2006 on have checked in at nearly $1 billion or more (in 2006, the company reported revenues of $996 million and in 2007, $1.21 billion).  Never in Crocs history did the company bring in more than $1 billion in revenues in a year.  And keep in mind we’re only talking about revenues here.  Netflix profit margin has been expanding consistently through the years.

Rather than a fad, Netflix has spent time and money in building out an impressive utility-style service on which subscribers have come to rely.  Moreover, the company has taken significant steps to ensure that it remains a step above any competition in transitioning from traditional media consumption devices towards the “cloud” and the Internet.  While the stock only recently took off (I say recently relatively speaking here, as it’s really since the March 2009 bottom that it went ballistic), Netflix had been steadily building out a long term vision.

In the WSJ article they offer the following observation:

Netflix needs to keep adding to its subscriber base, both on the Internet and by mail order. One way to increase sales is to deliver its streaming videos through television, not just over the Internet. Buying a company like TiVo could provide Netflix with the set box technology to get into people TV’s. But TiVo has been rapidly shedding business.

This shows a clear lack of understanding as to how people use Netflix and how the company makes money.  One doesn’t have to venture far to learn that Netflix is available for streaming on TV through the Playstation 3, Xbox, the Wii and the Roku streamer, among other devices.  Netflix very much enjoys a solid TV presence ALREADY!  Additionally, subscribers can now access the entire streaming library on the go using the Netflix iPad app.  Streaming isn’t about “increasing sales”, it’s about offering subscribers the latest and best way to access the growing library of watchable content.

The WSJ correctly points out that there are significant barriers to entry in Netflix market, whereas Crocs enjoys no such advantage.

Netflix has the license to 24,000 streaming videos and 100,000 DVD titles that it sends through the mail….While Coinstar’s Redbox kiosks offer $1 rental offerings (Netflix offers monthly subscriptions as low as $5), Bloomberg notes that Coinstar is trying to “close the gap” in its offering of 200 titles, compared with Netflix’s 100,000. That is quite a gap.

The fact that Netflix steadily built and invested into growing its businesses has afforded the company a comfortable moat against competition.  A head start in innovation makes it difficult for even better capitalized rivals to capture Netflix market, hence the ongoing rumors that Amazon may be an interested acquirer.

Far from the Next Crocs

It’s one thing to claim that Netflix stock is overvalued, another to posit the question whether “Netflix is the next Crocs.”  Not too long ago, Felix Salmon argued that Netflix stock was overvalued because the company is essentially a utility provider–a database of movies in exchange for a fixed monthly cost, not too different than how people subscribe to cable.  While I disagree and see avenues for significant growth, there is far more merit in asserting equity overvaluation, than in analogizing Netflix to a hollow one-hit wonder company which made little sense being a publicly traded stock to begin with.  As is always the case with a retail product, Crocs was always at risk of the incredibly fickle consumers tastes, which these days change on a daily, or even hourly basis.

The WSJ article seems to suggest that the hit taken by Netflix’ shares following their earnings report may instill a sense of panic in the company to do something quickly in order to increase its revenue growth rate.  That suggestion is missing the point.  Netflix is where it is largely because they have not concerned themselves with the volatile and fickle analysis of quarterly earnings reports.  It’s not often that you see shareholders flee a company with rapidly accelerating earnings growth and improving profit margins, and only natural for a stock up over 125% above its price a year ago today to experience a short-term pullback.  Even Apple (NASDAQ: AAPL) pulled in on its way to world domination.

Disclosure: No relevant position.

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