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NFLX AT A GLANCE

P/E ► 27.2 AVG EV/EBITDA ► 8.11 AVG ROA ► 20.5% HIGH ROE ► 38.7% AVG Debt to Equity ► 1.12 AVG Current Ratio ► 1.15 AVG Interest Coverage Ratio ► 67.4 HIGH

 

 

 

 

 

 

Netflix (NASDAQ: NFLX) is the world's largest video rental subscription service, having pioneered the model and charging customers a flat monthly fee for unlimited video rentals without late fees (cutomers are not allowed to have more than a few videos out at any one time)^[1]. As of the end of 3Q09, the company has built a subscriber base of over 11.1 million in the United States, a 28% YoY growth from 8.7 million subscribers^[2]. Because it sends DVDs by mail, Netflix title selection - with over 90,000 titles - is far larger than the average video store. During the week of July 13, 2009, NFLX's stock experienced a jump on rumors that Amazon was interested in purchasing the company.^[3] At this point, officials from both companies have declined to comment on the prospects of the deal.

In the online rental space Netflix faces competition mainly from Blockbuster, which has introduced and aggressively marketed a competing video-by-mail service known as Total Access to go along with its traditional in-store rentals. However, the stiffest challenge faced by Netflix in the long term is not Blockbuster, but growing demand for digital movie rentals courtesy of the internet and cable providers. To keep pace, Netflix has a digital rental service that allows subscribers to download and view movies and television programs instantly on their personal computers. In addition, Netflix is looking to partner with leaders in consumer electronics to stream movies and TV episodes directly to members' TVs. These devices currently include Blu-ray disc players and new Internet TVs from LG Electronics; Blu-ray disc players from Samsung ; the Roku digital video player; Microsoft's Xbox 360 game console; TiVo digital video recorders; and, soon, Internet TVs from Sony and VIZIO^[4].

Overview

Netflix is a subscriber based service that allows customers to rent DVDs through the mail and online. A dot-com era creation, it was started in 1997 by Reed Hastings in Los Gatos, California. Through sophisticated supply chain and an effective customer rating system, it has honed its competitve edge over Blockbuster in the subscription-based online rental space. Their 50 regional shipping centers across the United States help almost 95% of their customers receive their DVDs within a day of shipping, while their rating system gives customers recommendations based on their rental history^[5].

Subscription Plans

Netflix offers 5 different subscription plans that vary in monthly price from $4.99-23.99. A description of these plans can be seen in the table below.

Features

• Netflix sends you your movies: Subscribers choose which movies they want to rent at www.netflix.com. They can create a queue of films online and when movies are returned the next movie on their queue is shipped out immediately.
• Free DVD shipping and postage: The cost of sending movies back to Netflix is included in the subscription. Each DVD is sent in a reusable envelope that is addressed to the nearest Netflix facility. (Note: Netflix was required to change the design of its signature red square enveloped due to changes in postal regulations - as of May 2008, the square red mailers would have each incurred a $0.20 surcharge because the square shape is harder to process than normal rectangular pieces of mail.)^[6]
• No late fees: Subscribers can keep DVDs for as long as they like. The only disadvantage to doing so is that the next movie in their queue won't be sent until they have fewer DVDs than their plan allows at home.
• Online Viewing: Netflix subscribers have the ability to watch over 8,000 movies and TV episodes from the Netflix library directly on their PC.^[7] This feature is included in all of Netflix's subscription plans but to varying degrees. The amount of time subscribers can stream videos to their computers depends on their subscription plan. In most plans subscribers can view the same number of hours per month as they spend in dollars. That is, a subscriber on a $9.99 per month plan could stream 10 hours of video to their computer per month. However, with Netflix's $16.99 unlimited plan subscribers can stream an unlimited number of hours per month.^[8]
• Other Viewing Options: In addition to their online viewing service, Netflix released the Netflix box, a set-top unit built by Roku, in early 2008. The unit allows customers to view netflix movies directly on their home television without dealing with the by-mail rental process. In July of 2008 Netflix announced that they would also begin streaming videos to Microsoft's Xbox 360 over the Xbox Live platform.^[9]
• Free Trials: Netflix offers a 2 week free trial to any new customer.

Business Financials

In 3Q09, its traditionally sluggish season, Netflix reported 11.1 million total subscribers, a 510,000 subscriber increase over the previous quarter and a 25% increase over 3Q08 (8.6 million)^[2][10]. Total revenues amounted to $423 million, a 24% YoY increase, while net income, fueled by content growth cost-cutting, surged 48% ($30 million) from 3Q08^[2]. Its free cash flow stood at a meager $25.5 million after having repurchased over $245 million of stock in the first nine months of FY2009^[11].

Key Trends and Forces

Exclusive focus on Blu-ray DVDs presents short term opportunities.

In March 2006 the first high definition DVDs hit the market, and Netflix quickly announced that it would offer HD DVDs as soon as titles became available.^[12] About a month later Blockbuster announced that it too would begin offering some HD and Blu-ray DVDs in its online library.^[13] But in January 2008, Netflix, Blockbuster, and major DVD retailers like Wal-Mart Stores (WMT) and Best Buy (BBY) announced that they would begin phasing out HD DVDs and offer only Blu-ray discs. Exclusive focus on Blu-ray technology should boost the format's popularity, and the economies of scale created when hardware manufacturers and production companies switch to producing these discs exclusively should bring down prices for the equipment. Since Blu-ray discs are much more expensive than a standard DVD, this could encourage new owners of Blu-ray players to rent rather than buy, driving up subscriptions for Netflix.

PPV, on-demand and TiVo undermine demand for the Netflix product

The emergence of new technology in the media industry is a potential obstacle to Netflix. Technologies such as high-definition pay-per-view, video on-demand, and DVR enhance people's options for home movie viewing and lessen the need to rent discs. Cable and satellite companies are continually enhancing these offerings to compete with each other, undermining Netflix's core business as they increase the library of movies that their customers can view for free with an on-demand subscription. Netflix will have to find an answer to the convenience of VOD and TiVo if it hopes to retain its market share in the long term.

Online movie viewing may make the Netflix product obsolete in the long term

The growing popularity of online video viewing threatens Netflix viability and on January 16, 2007 the company announced that it would begin offering instant online viewing capabilities to its subscribers at no additional cost.^[14] With this feature customers can view movies directly on their personal computers through the Netflix website.

Piracy could lower the demand for the Netflix product

The ability of consumers to illegally replicate DVDs is a major concern for companies like Netflix. Piracy allows people to receive the product Netflix offers without paying for a subscription and this can certainly hurt their earnings. Intellectual property laws and regulations can help to prevent such piracy and to protect Netflix in such cases. The illegal copying of intellectual property has been a major concern over the past years, especially in China, where regulations and enforcement are much more loosely applied.

Competition

Netflix competes with a number of online and retail media rental service providers as well as with cable and satellite television providers. Its most important competitor is Blockbuster (BBI), the country's largest retail video rental store chain. Other competitors include: Tivo, which provides digital video recording (DVR) hardware and service, Amazon.com, who launched an online rental and purchase service called Unbox in 2006, and subscription based TV channels such as HBO and Showtime.

Comparison to Blockbuster

In 2004 Blockbuster introduced its Total Access program, which allows subscribers to rent movies by mail and furthermore, subscribers have the option to return rented DVDs to Blockbuster stores. Total Access was the first service to provide direct competition for Netflix, which at that time enjoyed 97% of the market share for rentals through the mail.^[15] Total Access allows subscribers to rent movies by mail and furthermore, subscribers have the option to return rented DVDs to Blockbuster stores. Blockbuster has been gaining market share from Netflix since this program's inception. The below table compares the cost and variety of mail service subscription options of Blockbuster (BBI) and Netflix.^[16]

Online Video Competitors

• TiVo (TIVO) & Amazon Unbox: In September 2006 Amazon launched its Amazon Unbox service which provides TV shows and movies for rental and purchase. The service is also available to TiVo subscribers who can rent movies directly to their DVR to watch in their home.
• Apple (AAPL) & Fox : Apple and Fox teamed up to begin offering movie rentals through the Apple iTunes store starting in early 2008.^[17] This service provides increased competition in the online movie rental market, specifically in digital rentals. Furthermore, the AppleTV, which was introduced in January 2007, allows people to rent and stream movies, television programs and YouTube.com videos directly to their television.

References

1. ↑ NFLX 2008 10-K pg. 1  
2. ↑ ^{2.0 2.1 2.2} "Netflix Announces Q3 2009 Financial Results" 8/22/09
3. ↑ Benny Evangelista (July 17, 2009). Netflix Stock Rises on Amazon Rumors. Newsfactor.com.
4. ↑ "Netflix Announces Upcoming Schedule of Events with the Financial Community" Netflix, Inc
5. ↑ "How Netflix Transformed the Home Entertainment Industry" The Epoch Times, 9/30/09
6. ↑ MSN Money - Top Stocks: Post office seeing red over Netflix envelopes, December 6, 2007
7. ↑ Netflix Quarterly Report (10-Q), Third Quarter 2007.
8. ↑ www.netflix.com
9. ↑ "Netflix Brings On-Demand Video to the Xbox: Another PC to TV Bridge", www.seekingalpha.com, July 16, 2008.
10. ↑ "Netflix 3Q Earnings Rise 48, but Stock Falls" Google News, 10/23/09
11. ↑ "Netflix's Stock Buybacks: Money to Burn," Wall Street Journal, 10/24/09
12. ↑ Press Release January 24, 2006, retrieved 12/28/07
13. ↑ Blockbuster Queuing Up HD DVD Titles, www.homemediamagazine.com, April 13, 2006, retrieved 12/28/07.
14. ↑ Press Release January 16, 2007, retrieved 12/28/07.
15. ↑ Jennifer Netherby, "Blockbuster Nips Netflix Market Share, Video Business, 3/3/2005, retrieved 12/27/2007.
16. ↑ Netflix, Blockbuster
17. ↑ Liz Gannes,"Apple to Announce Movie Rentals at MacWorld?", Matoumba.com, retrieved December 27, 2007.