Netflix and the New Media Model
Yesterday Felix Salmon blogged about the valuation of Netflix (NFLX) and made the claim that the company is overvalued based on the premise that they are “just a middleman, a delivery company….that [should] be a commodity, rather than something trading on a p/e in the mid-30s.” I am a regular reader of Salmon’s site, as he is one of the more informed and important financial bloggers out there, yet I was surprised to see such a column from him. This is partly due to the fact that Salmon rarely talks about valuation metrics in particular equities, but more to the point, I believe Salmon is one of the web’s most savvy entrepreneurs who figured out a way to monetize his writing and ideas in a dynamic and changing media landscape. Recently, Salmon and Henry Blodget engaged in a debate over the content vs. clicks-based monetization of webbased media.
I first want to stress that on a technical basis, I absolutely would not consider investing in Netflix at this moment in time. The stock is extended on multiple oscillators and is well above both its first/minor ($70) and second/major ($60) support levels. I do however think that with a pull in and a higher base established, the stock could be ripe for an entry. That being said, where I think Salmon is wrong is that Netflix is not purely a utility company just yet and they are not as prone to Post Office-based risks as Salmon asserts. The Post Office is Netflix’ past, their future is digital. Netflix is in fact a company, with expanding profit margins, a fairly modest forward p/e of ~24 and a slightly more robust PEG (price/earnings to growth ratio) of 2.07. These metrics reflect the fact that Netflix is very much in its exponential growth phase and that growth is THE story with regard to the evolution in media delivery.
Just two weeks ago, Larry Kramer, the founder of Marketwatch, stated that media is in the midst of a “Gutenberg Moment” and is in the process of shifting to a content-driven model of monetization from an ad-driven one. Kramer asserts that “The habits of content consumers — news consumers, information consumers, entertainment consumers — are totally up in the air. So is how much they watch at home, how much they watch in movie theaters, and how much they watch on portable devices. ” At this point in time, Americans have a nearly insatiable demand for “on-demand” and personalized content. With Netflix taking over the digital distribution landscape via devices such as the X-box, Playstation 3, the Roqu, etc, they are simultaneously improving their profit margins and creating an entirely new mechanism through which consumers can watch media and most importantly they are the first, most prominent, and best positioned to succeed in the space.
Anecdotally, I am fairly new to Netflix. I am not a big movie buff by any stretch and when I watch movies I do so from the comfort of my couch as opposed to visiting the theater (Imax has inspired the theater-goer in me, but that is a different story altogether). What inspired my subscription to Netflix was the availability of a nice chunk of their library via the digital distribution mechanism. While their digital and DVD libraries are incomparable right now, I believe that should change moving forward. For the most part, I am a high margin subscriber to Netflix and am looking forward to continued growth in the in the digital domain of the service. I infrequently engage in the Post Office based Netflix services and yet still pay the same monthly fee as one who is a manic mailer of DVDs.
Perhaps more interestingly, for my father’s birthdays, my sister and I purchased a Roqu player. He is a tech-savvy person but is far from an early adopter of new technologies. Already he realizes that the Roqu is a staple that will be a centerpiece of his home entertainment system comfortably into the future.
Taking the story one step further, I now know people who altogether forgo cable or satellite tv in favor of on-demand centric services. Obviously such a setup is tough for a sports nut, but for one who watches tv shows and movies and not much else, you don’t need to have cable anymore. What people want now are ready-to-view options that can be accessed without pre-planning. If the generation X-ers start fully buying into this notion of content-based entertainment costs, there will be significant pressure on Netflix to upgrade and expand their library and to further develop their distribution mechanisms. While this is a capital intensive project in the short-run, revenue-based growth is substantial.
For a company in such a dynamic and transitional phase of media delivery, a forward p/e of 23 is fairly modest. Yes, at this very moment in time, the stock is handsomely priced; however, considering the consistency of earnings beats and the improvement of profit margins the company is not trading as a utility, but rather a real growth story and a new way to watch tv.