Friday, 31 January 2014

Netflix TV on demand

Netflix (NFLX) is the world's leading internet television network. It is not a pay per view but an unlimited viewing service that charges a flat fee of US$7.99 per month. It's 45.8 million users view more than one billion hours of TV and movies per month. According to some statistics NFLX video usage is more than 10x its rivals Amazon and Hulu. The same article states that NFLX represented 31.6% of all downstream traffic September prime time in the US with Youtube second at 18.6%.

Apps replacing channels
The overall industry is benefiting from the tailwinds of increased internet adoption, frustration with linear TV, increasing cable pricing and its advertising. Even NFLX's competitor Hulu which had 3 CEOs in 2013 grew paid subscribers an impressive 65%. The majority of NFLX's viewing is on internet TVs but tablets and phone viewing are growing with many subscribers using Netflix on multiple screens. NFLX started out as a DVD mailing service and began offering its streaming service in 2007. It is now moving towards more exclusive content arrangements which cost more but allow NFLX to offer a differentiated service similar to HBO and its series.

Even quarterly earning calls are semi-exciting
Earning calls tend to be dreary and staid events. NFLX has ramped up the excitement factor by conducting its quarterly earning results over Youtube. NFLX further increased the excitement factor (see video below) by joking that a competitor HBO CEO's password is 'Netflix B*tch' in response to a question that HBO does not mind customers sharing passwords for free viewing. Its classic viewing if you're into watching quarterly company reports.

Fuzzy connections?
The main risk apart from continuing execution against competitors is internet neutrality. In other words all data on the internet is treated equally there has been no discrimination of charging users differently because of the content or site. This has been challenged recently so now a domestic ISP can legally impede the video streams or charge NFLX or its users more otherwise they could slow or limit the streaming experience. NFLX does not believe it is too much of an issue because these same companies are growing their broadband business but it is something investors should keep an eye out for.

The other risk which is also an opportunity are content payment obligations. As of the end of 2012 NFLX had $5.6 billion of off balance sheet obligations, basically payments for content that are fixed. The risk for NFLX is if a large number of subscribers cancel NFLX it still has to pay a fixed amount for its content. Given the recent large increase in subscribers this is looking less and less likely.

Going global
NFLX has 34.3 million subscribers out of nearly 110 million households in the US. The next major growth area is international currently at 11.5 million paying subscribers. The international division is not yet profitable but with planned moves into Germany and France the fourth and sixth largest broadband markets in the world this should quickly change. NFLX has said in the past that Canada broke even within two years.

Generally content is bid for on a country by country basis. The beauty of NFLX's model is that its original pieces such as Orange is the new Black and House of Cards not only attract users to the service but are also multi-territory so they only pay once but monetise around the world. The market is focused on subscribers because NFLX generally pays a fixed fee for a defined time period, obviously adding more subscribers is extremely profitable. NFLX trades on a high 79x earnings multiple and has a large market value of $24 billion but there is upside in subscriber growth and pricing. NFLX have hinted at future price increases at only $7.99 a month it is too low compared to the average cable bill of  US$78.

For consumers the only problem for consumers is choice, you can spend more time searching for something to watch than actual watching!  Unfortunately NFLX is not yet available in Australia consumers here should stay tuned.


Disclosure: Decisive has no position in Netflix (NFLX) stock 

The material in this article is for informational purposes only and in no way constitutes a solicitation of business or investment advice. The material has been prepared without regard to any client's or other person's investment objectives. Before making an investment decision you should consider the assistance of a financial adviser and whether any investment or service is appropriate in light of your particular investment needs.