Once Wall Street has a down on you, it has a down on you. Netflix has just found that out, losing over $1 billion from its stock value, after announcing record breaking results. Within weeks it will be back.
There seem to be issues, say analysts, but underneath that is a failure to classify exactly what Netflix IS. One technology analyst group compared the Netflix ARPU (average revenue per user) to Comcast’s this week, pointing out that with an ARPU of just over $12, US cable companies have little to fear and especially not Comcast with an ARPU of $133.43 last quarter.
This, like many other statements is cockeyed logic. Comcast is asking people to pay ten times the price of a Netflix subscription ‘ how long can customers resist cord cutting to services like Netflix when there is that much disparity, but do we see analysts getting behind a Comcast short? No the price continues to rise ‘ but mostly because now it now owns a content business in NBC.
This is because Comcast is a cable company and analysts have had 20 years to understand what a cable company is, and they do, deep down in their gut. They still have trouble seeing what Netflix is and they worry that it doesn’t own any cables?
Here are the issues as we have picked them up from the coverage. Competitors will emerge to Netflix. TV Everywhere will make Netflix unnecessary. Content pricing will go up. There will be pressure on subscription prices. Studios are experimenting with new release windows. Costs of streaming delivery will go up. Broadband bandwidth caps will come in and strangle the business. The online business has a higher churn rate than DVD rental, so subscriber acquisition costs will go up. Netflix continues to carry postal delivery costs, because lots of people still take 2 or 3 disks a month in the post, as well as online costs, so its costs are duplicated.
One analyst calculated that customer acquisition costs would rise to $500 million and grow faster than savings in reduced DVD shipments and related handling costs.
If you think for say about a minute and a half about all this, you find that most of these ideas a) contradict one another, so can’t all be true and b) are excuses to get out of a stock the analysts don’t understand.
The gains this quarter were just 3.3 million subscribers, at an average of $12 a month, annualized that’s $475 million ‘ so this quarter’s growth takes care of that $500 million rise in customer acquisition costs, on its own.
Just how is a rival meant to stand the same kinds of costs ‘ even one as powerful as Apple or Amazon ‘ if it has to match all of the those customer acquisition costs? Well of course companies like Time Warner Cable and Cablevision don’t have to acquire customers since they would use their attempts at TV Everywhere in order to retain customers. They would GIVE content away to KEEP subscriber revenue? Just one small problem and that’s their content agreements which usually allow an exploitation veto to the content producer ‘ and giving content away free, especially when targeting a tablet, just to kill a customer like Netflix, which is paying the content owners for a service ‘ is not going to enamor cable companies to content producers. Which is why, right now, those same content companies are suing Time Warner Cable and Cablevision, so they can get paid for their TV Everywhere content, especially where a tablet is concerned.
In fact look at this from a content company’s point of view, specifically a cable network. Netflix represents a new buying channel which pays with one large check and takes away the conundrum of how to make more content monies off the internet. Why would they conspire with the status quo ‘ in this case the cable companies, in order to prevent that from happening. So TV Everywhere will only ever take off at the same kind of costs to cable operators as Netflix, but with zero revenues. And that’s assuming that TV Everywhere is not banned by the FCC, as a monopoly attempting to secure a second monopoly.
Cable companies don’t have the content variety, the long tail, the search capability, the device partnerships nor the geographical reach of Netflix. They have VoD services which are entirely for their customers, and their libraries are smaller, and their arrangements for content delivery are network bound.
But it’s that issue about Status Quo ‘ as far as investors are concerned Netflix is an upstart and they want to continue to ignore the fact that new business models will harm their long standing love affairs with cable and broadcasting and change the value of studios. In fact when can you remember that voting with the Status Quo has ever worked out for investments markets?
Let’s go through the issues. Yes competitors will emerge, but the market is huge. And any start-up competitor is dead for all the reasons that the analysts make ‘ it’s tough to build momentum where there is already a rival with 23 million loyal customers. TV Everywhere may emerge, but given that it will be at the same cost to cable companies as to Netflix, anything run purely to prevent churn and without wanting to make a profit, is invariably run badly, and will have less content, available in less attractive ways. Netflix can target tablets with impunity (because it has already paid an IP license), cable MSOs will have to seek fresh licenses.
Why would content pricing go up? Sure Netflix will want better and better content, and so it will fund it, and own exclusives, and that will cost more, but the outcome will be more loyal customers and more customers. If content has found a new source of revenue, it is happy. And content pricing goes up every year for everyone who uses it, except when someone big offers a ‘take it or leave it’ approach, and then content will usually take it.
How will there will be pressure on subscription prices? What organization can license all the content that Netflix has and still charge less for the service than nothing. That’s right Netflix charges No Extra for the streaming option, and has already predicated its costs based on its DVD rental formula. Amazon may be able to compete on that basis, but Apple can’t and YouTube certainly can’t with all the suspicion that Google raises in the minds of content companies already. And who else is going to be able to attract so many hardware options as Netflix, and get the service loaded directly onto the devices, pre-shipment.
It is trust that studios are experimenting with new release windows but that’s because they are losing impact with older ones. Netflix is a new release window too, but so far it has only had classic movies, already in the DVD release window for 28 days ‘ what would happen if Netflix began to deliver new releases, prior to the DVD window into the market, as cinemas and DVD sales continue to fail? It’s appeal would rise. Studios may offer films early to cable companies, but they might just as easily do it for Netflix too.
And although costs of streaming delivery will go up, it will go down as a percentage of revenue over time. As Netflix gets more traffic why wouldn’t it opt to use new cheaper services, for instance the new Verizon CDN delivery service, just out of the blocks? Let’s see Comcast bully Verizon into paying higher peering charges the way it has bullied Level 3.
And if broadband bandwidth caps come in, and they come in too low, then investor analysts will have a lot more to do than mark down a stock they don’t understand. They will have to write off great chunks of every broadband player. Caps, where they do come in, will accommodate the watching of movies or they will see customers leave in droves. In Canada where ISPs reminded Netflix customers of caps, Netflix retuned its streaming formula to use less data, and has grown just as fast since this alteration.
Finally yes the online business has a higher churn rate than DVD rental, but all that has done so far is push churn from 3.8% to 3.9%. Big deal.
We could go on. But this was in fact classic Apple behavior, with Netflix (as Apple has sometimes done) wanting to set its targets low to the market and highlight dangers, so that it can beat its predictions and continue to grow. What if Apple had failed to deliver with a product or had suddenly had a hiccup with a product? Oh yes it just did, the iPad shipments went through the floor last quarter. What did analysts do, bid up the stock, saying it would take a bigger market share because if Apple was component constrained, rivals would be even more so.
So when Netflix says we will make a loss because we are investing in customer acquisition costs in Canada and in international markets, shouldn’t the analysts applaud the company’s grip on the situation. It’s hard to beat up the company for grow being expensive and then beat it up again because it is trying hard to grow by committing funds. But once Netflix gets into the heartland of Europe, with its 550 million inhabitants, with about two thirds of them on broadband ‘ and where legislation already exists to prevent blocking of this type of service, then it will be unstoppable.
Hulu has already failed to get into Europe, and yet Hulu Plus is raised as a key rival service ‘ but it cannot get content rights in Europe, where Netflix, we are sure can. What should happen in the US is that someone should sell Hulu Plus and Netflix together, in a single service, perhaps along with local broadcast channels and there would be an almighty cord cutting exercise that would bring down US TV as we know it. But that’s never going to happen, right? Better just go with the Status Quo. Well if ATSC M/H ever takes off in the US, then it will almost certainly be installed on devices that already have Netflix on ‘ wow that could lead to serious cord cutting.
The truth is that like Apple, YouTube and Facebook, Netflix has become a brand to the US consumer, and they love it. To knock it off its perch, someone has to come up with a cheaper, better, easier to use service and build a brand, and that will take years.
Those Netflix results in case you haven’t read them, it added 3.3 million net subscribers, the highest it has ever added to end with 23.6 million subs, including 800,000 in Canada; quarterly revenues were $719 million, up 46% on a year ago and 21% on the immediate past quarter; net income of $60 million, a record, and its highest ever margin. But the company listed all of the potential pitfalls which the analysts listed above, and predicted a loss for international operations and continued to talk about entering a new market outside the US (which we assumed in in Europe though it might not be as there are other candidates), but also even better profits for the US operation. That’s terrible, better bale out of the stock.