NFLX: Now We're Cooking (The Business Model)
The Market Ticker - Commentary on The Capital Markets
2010-11-22 08:54 by Karl Denninger
in Company Specific , 4 references Ignore this thread
NFLX: Now We're Cooking (The Business Model)*

From this morning:

"We are now primarily a streaming video company delivering a wide selection of TV shows and films over the Internet," said Reed Hastings, Netflix co-founder and CEO.  "Today's action reflects the tremendous customer value we've injected into streaming from Netflix, our initial success with a pure streaming service in Canada for $7.99 a month and what our U.S. members tell us they want."

The company also announced that the price of its popular subscription combining unlimited movies and TV shows streamed instantly over the Internet and unlimited DVDs delivered quickly by mail, with one DVD out at a time, will increase by a dollar a month to $9.99.  Prices of subscription plans allowing for more DVDs out at a time will also increase and are detailed at  Price changes take effect now for new sign-ups and in January for existing members.

The stock is roaring this morning, up over $10:

My concerns and issues remain:

  • The business model relies on what comes down to poaching bandwidth.  That is, the last mile is paid for by someone else.  And despite what people like to claim (the old "I bought unlimited and that's what you sold me", which incidentally is true), the fact remains that the networks are not built out to sustain, nor can they sustain, saturation levels that this service has and will demand without dramatically higher costs.  How much higher?  To put it in perspective my "business level" cable service is the same speed as the "personal" service that COX also sells but is three times as expensive.  That's because COX expects me to burn up the line to the full capacity I bought (and I do) - they don't expect the home users to do the same.

  • Net Neutrality figures large in this matter.  This will add fuel to the fire.  But for those who are strong net-neutrality supporters, realize that if you win you will lose.  That is, if the carriers are forced to allow Netflix to saturate your line the response will simply be to raise the price on your Internet service.  That is, if they can't "tax" the outsized impack back to Netflix, they'll bill you for it whether you use it or not.  Be careful what you wish for as you just might get it.

  • The company is now trading at a P/E of seventy.  This is nosebleed territory - but the company has managed to keep it up there while the price has advanced.  This is a momentum-bubble trade.  Good trade if you catch it right, but be careful - these pop, and when they do they usually do so in a really ugly fashion. 

On a forward basis I think these guys are digging their own grave.  Moving toward a fully-online content delivery system sounds great, but it's only great because they're poaching other people's build-out costs.  Theirs are near zero - their only recurring cost is for whoever they pay for distribution.  But in the Internet world that's people like Akami (AKAM) and similar; it's not the people who built the lines into your home - those are Netflix' competitors in this case!

I'll be watching these folks carefully, and I sure won't be buying the stock.  In fact this looks like it will become an absolutely delicious short at the right time - but that day, obviously, is not today.

Of particular interest to me will be how many people revolt on the price increases for their "traditional" service, and how their online streaming catalog evolves.  As it sits right now the newest releases are only available via physical delivery (a niche that Redbox and similar cover quite well also if you're near one) while the streaming service is mostly about older films, TV shows and the like.

Watch the margins and the operating leverage, along with any signs of serious pushback from the "last mile" folks.  The latter I expect to see in earnest within three to six months - tops.

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