Netflix builds a best-in-class empire

The video-subscription company has made all the right moves. Some analysts say growth has just begun.

By TheStreet Staff Jul 15, 2010 11:22AM

more financial news from the streetCredit: (© Paul Sakuma/AP)
Caption: Netflix DVDBy Jason Notte, TheStreet

 

Netflix (NFLX) forced the closure of rival Movie Gallery, caused Blockbuster to implode and prompted retailers to streamline their approach to video sales en route to big-budget growth. Those were just the first items in the queue.

 

Netflix is getting five-star reviews from investors and catching the eye of larger competitors such as Time Warner Cable (TWC) and Comcast (CMCSA) based on how it handled last year's tough economic climate: Sitting it down and showing it movies from the comfort of its Blu-ray players, game consoles and smart phones.

 

While disc-based competitors struggled, with Movie Gallery declaring bankruptcy and liquidating its assets and Blockbuster closing nearly 1,000 stores and having its stock delisted from the NYSE as it struggled with debt, Netflix expanded its instant-streaming offerings and boosted the number of subscribers.

 

In July 2009, Netflix's subscriber base was 10.6 million, its stock price hovered around $39 and its instant streaming was available primarily on Roku boxes, LG and Vizio HD televisions and Microsoft's (MSFT) Xbox 360.

Since that time, Netflix has expanded its streaming options to Sony's (SNE) PlayStation 3 and Bravia HD televisions; Nintendo's Wii; TiVo recorders, WD TV media boxes; Seagate media boxes; and Samsung, Sony, Panasonic (PC), Phillips, LG, Vizio and Best Buy (BBY) Insignia Blu-ray players. It also announced apps for Apple's (AAPL) iPhone and iPad and demonstrated an app for Microsoft's Windows 7 Phone.

 

To fill out its streaming library, Netflix made a series of content deals with Disney (DIS), MTV Networks and independent filmmakers such as Criterion Collection, Gravitas Ventures, Kino Lorber, Music Box Films, Oscilloscope Laboratories and Regent Releasing.

 

The biggest, and riskiest, deal came in January, when Netflix agreed to a partnership with Warner Brothers that engorged its catalog of instant offerings, but imposed a 28-day window between DVD and Blu-ray sales dates and Netflix availability. Seen as a last-ditch effort to fend off competitors like CoinStar's (CSTR) Redbox and to avoid DVD purchase restrictions imposed by Target (TGT) and Wal-Mart (WMT) -- both of which were key to Netflix's supply chain -- the gambit worked, and similar deals were reached with Fox (NEWS) and Universal studios in April.

Today, Netflix has more than 14 million subscribers, while its base subscription price for DVDs and streaming service has held at $8.99 a month. (An update on subscribers comes July 21, when Netflix reports second-quarter earnings.) Netflix investors have scored a 194% return in the past year, with Netflix agreeing to two buybacks totaling $600 million. Netflix also topped the benchmark S&P 400 this year, with a 113% gain that outpaced the second-best performer by more than 20 percentage points and dwarfed the index's 1.3% advance.

 

Meanwhile, Netflix's easygoing employee policy lets the company recruit and retain the best and brightest by offering them unlimited vacation days and relaxing the dress, tattoo and piercing code for its customer-service employees.

 

Happy employees beget happy investors as those lucky enough to pick up $15 shares of Netflix during its initial public offering in May 2002 -- when Netflix was limited to 900,000 subscribers receiving DVDs by mail -- have seen a 780% return. Compare that to Comcast shares, which have fallen since May 2002, or Time Warner Cable, which have belly flopped more than 56% from their peak of $127.50 in 2007.

 

Perhaps the only better deal in May 2002 was Apple, whose shares have skyrocketed 2,132% since then.

 

In that time, Netflix has built up a market value of more than $6.1 billion which, as Lazard Capital Markets analyst Barton Crocket told the Wall Street Journal last week, values Netflix as if it had 26 million subscribers instead of 14 million. That inflation would still lag behind HBO's 29 million adherents, but would eclipse Showtime (18 million) and Netflix partner Starz (17 million). Some analysts love that growth potential, as Citgroup (C), Jefferies & Co. and Connacord Adams still rate Netflix a buy.

 

There's also been a flurry of downgrades to hold or neutral among analysts, including Stifel Nicolaus, Merriman and Kaufman Brothers, thanks largely to an increasingly competitive marketplace.

 

Blockbuster may be dazed, but Redbox has signed distribution deals with Sony Pictures, Paramount Pictures and Lionsgate and sealed pacts with Universal, Warner and Fox with a 28-day window between purchase and rental dates similar to Netflix's agreement.

 

Meanwhile, Best Buy, Sears (S) and Wal-Mart this year joined Amazon (AMZN) and Apple in offering video download services -- with Wal-Mart acquiring high-definition streaming service Vudu in February in a direct parry to Netflix.

 

Fox, ABC and NBC's joint streaming project, Hulu, just added a $9.99-a-month commercial-supported subscription service to placate lost partners like Viacom, which didn't see any purpose in Hulu's profit-averse free model. Comcast and Time Warner haven't been idle, either, as each has trumpeted its window-free on-demand viewing of newly released video titles.

 

Netflix's response? Yawn.

 

Perhaps remembering that Blockbuster rode to ruin on "guaranteed to be there" new releases of "The Pacifier" and other cinematic gems, Netflix has been content to stockpile catalog titles -- teaming with Akamai (AKAM) to offer a more extensive selection of 720p high-definition streaming movies and television shows to the 48% of Netflix subscribers that use its streaming service -- and let the cable companies debate the dubious merit of bringing "The Bounty Hunter" into American homes first.

 

Just to be safe, though, Netflix signed an exclusivity agreement with Relativity Media earlier this month to stream that company's films, including Mark Wahlberg's upcoming project "The Fighter," during the pay-TV window.

 

Netflix's growth potential has stirred rumors of a possible buyout by Amazon or Microsoft, among others, but there could be a very long wait on any such plans. As the folks at Trefis point out, Netflix's $8.99 subscription price -- which is actually down after price wars with both Blockbuster and Amazon -- gives the company ample room to maneuver.

 

Though a price hike would reduce Hulu's competitive advantage against Comcast, Time Warner and Hulu, it could satiate studios seeking greater returns and motivate channels like ESPN -- which just agreed to stream content over Microsoft's Xbox Live subscription service -- to join Netflix's queue of partners and, in turn, boost both Netflix's share price and subscriber base.

 

Meanwhile, by catering to the 46% of viewers aged 18 to 25 who spend as much time streaming video as watching TV and the 32% who use their computer as a go-to device for on-demand content, according to a poll by RealNetworks, Netflix is providing both shareholders and subscribers with growth they can watch instantly.

 

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