Netflix stock analysis

A s h n a D h a w a nE m i r a A j e ti

N e e l B h a l a r i aTa r u n C h u g h

NETFLIX

Reed Hastings

Founder, Chairman

Neil Hunt

Chief Product Officer

Leslie Kilgore

Chief Marketing

Officer

David Wells

Chief Financial Officer

Patty McCordChief Talent

Officer

Management Team

• Founded in 1997 by Reed Hasting• Headquartered in Los Gatos, California• Offers online flat rate DVD and Blu-ray disc rental-by-mail and video streaming• Serving more than 20 million subscribers• Employees-2,180 full-time employees• More than 100,000 titles of DVD• Distribution centers-more than 50• International Operations-Canada and Latin America (Caribbean, Mexico, Central and South America• Agreements and Partnerships with Nintendo WII, PS3, Xbox, Blu- ray disc players etc

Company Background

DVDS by mail

•Select •Receive •Watch •Exchange

How Netflix works

PLUS, instantly over the Internet to your TV

•Select •Watch Instantly •Anytime

How Netflix works

Mission-to be a great Internet movie service by satisfying its customers and providing them with the most expansive selection of DVDs; an easy way to choose movies; and fast, free delivery.

Vision-To be world’s best distribution platform

Objective-offer a superior customer experience by providing convenient and affordable entertainment and to revolutionize the home entertainment experience

Strategic Philosophy- to continuously improve the customer experience by expanding its streaming content, enhancing its user interfaces and extending its streaming service to more Internet-connected devices while staying within the parameters of their operating margin target.

Strategic Direction

Competition

Blockbuster Redbox Hulu/Hulu Plus

Amazon Vudu• Founded in 1985• McKinney, Texas• North America,

South America, Europe, Australia

• Provider of home video and video games, DVD by mail and streaming videos on demand and kiosks

• Subsidiary of Dish Network

• Mail service Cost-$11.99/ month

• Rentals (1.99-3.99)

• Founded in 2002• Oakbrook

Terrace, Illinois, United States

• specializes in the rental of DVDs, Blu-ray Discs, and video games via automated retail kiosks

• Subsidiary of Coinstar

• Cost-$1/ day

• Founded in 2007• Los Angeles,

California, United States

• Provide ad supported subscription service to bring current TV programs in HD to PC’s and TV etc .

• Joint venture (NBCUniversal,Fox Entertainment Group,Disney-ABC Television Group)

• Cost-$ 7.99/month

• Founded in 2008• Provides users to

rent individual films or episodes of television shows, which extends users' access to over 90,000 film

• Cost $79 per year

• Rent: $1.99-2.99• Buy:$15

• Founded in 2004• Santa Clara,

California, USA• To distribute

full-length movies over the Internet to television

• Subsidiary of Walmart

• Cost-$1-5.99 per video

• Timing Barnes and Nobles v/s Amazon

Barnes and Nobles late by 17months. Amazon has 30times market capitalization and 8 times the profit mrgin

Netflix v/s Blockbuster Right Timing Netflix profits increase by 7times and Blockbuster lost $1bn in revenue

• Investment/Capital for: Tie ups with production houses Supply Chain Management

Barriers to entry

• Substitutes Theatres, Concerts, TV

• Unique/Scarce Resources Patented software and content Bandwidth

Substitutes/Unique Resources

Threats Copyright Laws

preventing expansion Lawsuits

i. National Association of the Deaf

ii. Recommended Algorithm

iii. Throttlingi. Unlimited rentalii. One day delivery

Legal and Political Macro Environment

Opportunities Password Sharing

State of Tennessee, July 2011

Video Privacy Protection Act ($200,000 lobbying)

Threats Low Entry Barriers Rising Content Costsi. Increased competitionii. Excessive supplier

power Low Pricing Power Price Sensitive

customers

Economic Macro Environment

Opportunities 270 million internet users

in the US Aggregate 2.2 billion

users in the world Expansion in the

international markets with Canada, Latin America& UK

First Mover advantage in the streaming business

Great Recession has been a boon

Threats Price Elasticity is

highest for 18-34 demographic

Only 15% of the 18-25 age group ready to pay extra for Premium

Company is ignoring the baby boomers

Social/Demographic Macro

Environment

Opportunities 17% of US users use the

internet to stream videos

Time spent online has increased by 6%

18-34 age group have the highest affinity to Netflix

Multiple people households income>50k

Threats Fair usage issues First sale doctrine Amazon, Hulu are

strong competitors Piracy

Technological Macro Environment

Opportunities 93 million households

High Speed net 2013 Only 35% of the users

use smart phones Properitory software &

Streaming protocols 97% of the customers

receive DVDs in 1 business day

Threats Execution risks Increased content costs

due to broadening of portfolio

Negative contribution margin

Per capita income levels Tech infrastructure

Global Macro Environment

Opportunities 43 countries in Latin

America Q4 expects to have 2

million subscribers 20 million households in

the UK 60% pay for an online movie offering

• Objectives Focus on increasing the subscribers to 26 million by 2011 Maintain a healthy cash position to meet the growing content

costs obligations by issuance of new equity/debt Invest in innovative user interface and streaming technologies to

create a solid platform for the shift of subscribers from DVD business to streaming

Ensure that the international businesses become contribution profit positive within the next 2 years

(Contribution profit= revenues-COGS-marketing expenses)

Finance Internal Environment


Over the last few 5 years 38.8 % growth rate in net income

Vincent Chung 1055-5

2005 2006 2007 2008 2009 2010

Gross margin 31.7 37.1 34.8 33.6 35.4 37.2

Operating mar-gin

1.6 6.3 6.4 8.9 11.2 12.8

2.5

17.5

32.5

Finance Internal

EnvironmentProfit/Operating

Margin


Long term Debt to cash

2005 2006 2007 2008 2009 20100

100

200

300

400

500

cash (In mil-lions)


Current Liabilities and Cash flow

2005 2006 2007 2008 2009 20100

100

200

300

400

Current Liabitlities (in millions)Free Cash Flow(in millions)

Stock has given -63.06% return in the last one year Reached its life time high of $304.79 in July and its 52 week low in

November of $62.79



NETFLIX HAS GIVEN A NEGATIVE RETURN OF -63.06% YTD

S&P 500 HAS GIVEN

1.15%


THE FUTURE ESTIMATES ARE IN THE NEGATIVE

WALL STREET SHOOTS

FIRST AND THEN

THINKS


SeS

July 12, 2011

• Announces a 60% increase in plans by separating DVD by mail and streaming business

September 19, 2011

• Announces separating DVD by mail and streaming business

• Backtracks on the decision

October 24, 2011

• 800,000 subscribers leave the company

• Announces the first two quarters of 2012 will be loss making

November 22, 2011

• Announces issuance of equity to raise 400 million

Weaknesses

Weak Pricing power& price elasticity of customers

3% subscriber loss due to price changes

$2.9 billion dollar in content obligations in next 5 years

International expansion to be loss making for next 3 years

Negative share holder return in last 1 year due to lack of strategic direction


Strengths

Mid 30% top line and bottom line growth for 5 years

Consistent Cash flow growth

Low debt to equity ratio Early mover advantage in

streaming Linear trend in OM has

reached 11.2% in 2010

It is easy to drop an idea or a campaign because it isn't "ready." Many are still not satisfied with the content available through

theirstreaming video service. That hasn’t stopped Netflix to improve

over time

Re-branding strategy? A mistake?Netflix lost over 1 million subscribers after its price

increaseWell researched?Well planned strategy with segmented strategies for all possible scenarios?

Netflix split its brand into 2 different categories:2 separate websites, two sets of recommendations, 2 separate customer bases, 2 monthly payments. and2 separate places to get affordability, instant access and usability

FROM a company that sends out DVD-s in the mail TO one of the world’s largest media distributors

Marketing

• Strength 1st mover advantage - venture into the online DVD rental

retailing Large customer base over the years Strong relationship with major studios and independent film

studios(latest releases, low cost and niche market) It offers a proprietary recommendation system, quite accurate Recently sent out "refer-a-friend" cards for one free month of

service.

• Weaknesses High cost for the replacement of content Netflix business model does not really work with low volume

customers

Marketing Analysis

Customer acquisition is becoming both harder and more expensive.

Netflix seems to be spending much more on free subscribers than ever before.

Overall acquisition costs for subscribers showed a large increase from 2010 to 2011.

Marketing Expense

Objectives Reduce R&D costs by possibly partnering with an

expert company

Retract from further international expansion Its previous strategies of investing in locating itself

strategically has now moved to the strategy of content improvement.

However, adapting to the content appealing to an international audience needs further investment

Enhance video content in the US, follow Disney example

Operations

PRAISE FOR ITS TALENT MANAGEMENT PROGRAMS

Salaries are at the 90th percentile of the market Employees who meet the membership criteria are rewarded

with premium base salary levels. Not differentiating rewards by individual performance, but by

considering all members who prove themselves to be top performers.

Commitment to their style of performance management- show mediocre employees the door- Netflix has an annual “keep test” (double digit # people fail the

test yearly among the Netflix population of about 500 salaried employees)

Critical competencies in recruiting -in-house recruiting Careful avoidance of “incentives to stay” -vest schedules for its stock options

Human resource and ethical concerns

Netflix’s core product and its strength is delivering a very smooth, seamless, enjoyable customer experience.

The Netflix model and software are proprietary, making their unique features difficult to imitate

Core Competencies and Competitive advantages

• Internal Lack of Pricing Power Lack of strategic direction Brand dilution due to recent adhoc decisions

• External Lack on technological support in international markets Rising content cost

Key weaknesses

Deviating from the success formulae of unlimited DVD rental

Declining revenue/subscribers Increase content costs Low barriers to entry for new competitors

Central Problem

Pricing Strategy: Tiered System-Mature Content, Pay per view (Movies, Advertising with a low price)

Focus on US markets. Losing money in expansion. Form partnership with other streaming companies so they

are able to improve their bargaining power for content

Strategic Recommendation and

Implementation

Netflix stock analysis

Entertainment & Humor

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