Is It Smart to Bet Against Netflix?
I recently finished the book Netflixed, by Gina Keating. Besides being a fantastic read, the book had plenty of insights into the company’s management team and business model. It is a must-read if you are long or short the stock (disclosure: I’m neither).
The book was published in 2012, so it misses the last seven years of Netflix’s history. However, I think the story holds up well even with the TV landscape changing dramatically during that time. Reed Hastings is still the CEO, the company is still facing competition from traditional media, and Wall Street still doubts the stock.
Here are some of the best excerpts from the book.
They’ve Been Doubted From the Beginning
Back in its DVD rental phase, Netflix’s main competitor was Blockbuster. Famously, legendary activist investor Carl Icahn backed the company against Netflix. Why? Because his analyst friend thought Netflix might be a fraud:
“But Michael Pachter, an analyst at the financial services firm then known as Wedbush Morgan (now Wedbush Securities), who viewed Netflix as a sort of rental Ponzi scheme, convinced Icahn that Blockbuster was a stock to hold. Its strong brand, huge network of stores, and healthy revenue, would lead it to either eventually buy Netflix or put it out of business by starting its own online rental service.”
Lesson: Just because a company has a different business model than its competitors does not mean it is fraudulent.
(On the flip-side, this does mean you need to put in more due diligence before investing into a disrupter to make-sure you avoid a Theranos, WeWork, or the soon-to-be bankrupt Tesla.)
Competitors Have Always Undercut Netflix on Price
A cheaper price from deep-pocketed competition has always been part of the bear-case against Netflix. Here is an example from Blockbuster over 10 years ago:
“Antioco [the CEO] ridiculed the move as a timid half measure–like kissing your sister, he said. He argued for a deep chop–to $14.99–on the theory that their per-subscriber losses would be relatively small but Netflix would be seriously weakened if it tried to absorb the same losses from 2.2 million subscribers.”
Since then, other streaming competitors like Hulu and now Disney+ have undercut Netflix heavily on price (streaming services are not winner-takes-all, so it’s a little different, but the analogy still stands). What has Netflix done since then? They have seen their subscriber numbers hit 160 million while continually raising prices.
Lesson: Just because something is cheaper does not mean consumers will flock to it. Quality matters.
Disney Has Tried Digital Before
A lot of people wondered why it took so long for Disney to come out with a DTC streaming service. Well, I think I found at least part of the reason why:
“Disney also began testing two of its own digital approaches: a download service called MovieBeam, to rent Disney movies through a set-top box, and an advertising-supported streaming Web site for its ABC television shows.”
Both of these services, as you could have predicted, are dead. Why? Because the technology wasn’t there, and Disney had no idea how to build a consumer-facing digital service. That’s not their core competency.
However, this does not mean Disney+ will fail (I actually think it will be a huge success). What it does mean though, is that Disney is now competing with Netflix at its own game. And Netflix has a ten-year head start.
Lesson: Changing your business model is a lot harder and takes a lot more money than you think. This is especially true for bigger companies.
Netflix’s Old Competitor Was Very, Very Dumb
Plenty of times throughout the book you just shake your head at Blockbuster’s stupidity. Yes, hindsight is 20-20, but these are just some egregious errors.
“The tightening of the credit market in late 2008 made it tough for Jim Keyes to amend and extend blockbuster’s credit lines for a fifth time in three years to carry out his store expansion plan. A year into his tenure, Keyes was consumed with revamping Blockbuster’s stores into “full-service entertainment destinations” where, he envisioned, customers would drop in for a pizza and a Coke, or buy a book or a flat-screen television or hang out with their kids on weekends while waiting for a movie to download.”
It was 2008, and executives still thought a store-based approach for DVD rentals and video downloads would work. It’s truly shocking that Blockbuster went bankrupt right after this.
Investing Lesson: If their competitors stink, a business can absolutely thrive.
We now know how the rest of the story unfolded. Netflix dominated streaming for years, licensing content from Disney and other TV/movie studios. Now, almost every big player is creating their own DTC service to try and compete with them and capture a piece of the pie.
The difference between competing with Blockbuster vs. Apple, Google, Amazon, Disney, and HBO is stark. These are not inept executive teams, and they have seemingly unlimited piles of cash on their balance sheets. Netflix has also grown its long-term debt and has annual FCF losses of over $3 billion. A lot of smart money is thinking logically and betting Netflix cannot win in this scenario.
But we can’t forget the advantages Netflix has built. They are a decade ahead of everyone except Amazon and have the largest installed subscriber base in the world. Sure, in the short-run it could be profitable to bet against Netflix stock. But in the long-run? There’s no way I am doubting Reed Hastings and the track-record of the Netflix team.
Disclosure: The author is not a financial advisor, and may have an interest in the companies discussed.