Wednesday, March 09, 2011

Shorting Netflix

As a customer, I love Netflix. I love its services, its branding, its ease, its quality, and its pricing.

As an investor, I've shorted the hell out of it. A year ago, I loved the bonds and thought the company was fairly priced. Now, I think the company is way over priced and I'm even worried about the bonds, which don't mature for more than 5 years. . .

Here's why I'm short:

The company is trading at 66x earnings, and was as high as 80x, up 300% in the last year. This is 3x higher than AAPL, which trades at 20x and is a stock investors supposedly love. While earnings are expected to double next year, bringing that number down to 33x, it's still way to high. Want to know why? Business Model Risk and Competitive Risk.

Business Model Risk:
While the company absolutely dominates the market right now, there is no reason that can't change. There is no reason that can't change QUICKLY. There is no reason why NFLX has to be the winner or even exist in 10 years. They don't own content, they don't own distribution, they don't really own anything...except contracts/customers/technology, none of which are exclusive and all of which can be easily and cheaply duplicated.

Competitive Risk:
From a finance 101 perspective, the company will face significant competition from 4 or 5 of Porter's 5 forces of competition:

Competition from Peers: Amazon/Apple/Google... much larger, stronger companies.

Competition from New Entrants: Duplication is easy, they have no exclusivity with their content (who thought Facebook would become a competitor before yesterday?)

Pressure from Suppliers: Netflix got some sweetheart deals when they first talked about streaming video years ago. Those deals are up soon, and Netflix will have to pay up.

Actual Content: Don't forget, they pretty much only sell "re-runs." No new shows, no new movies.

Competition from Distribution: Cable companies, with whom Netflix relies on for distribution (Internet connections), but also takes $ from, can/will start making netflix or their customers pay for the bandwidth. Why can't Comcast create its own VOD/TV monthly subscription service? There is no reason at all. . .

Customer Loyalty: Currently this is high, but no annual contracts, and so if a better/cheaper product comes around Netflix will lose all pricing power. Price hikes are over.

Without content exclusivity (like DirecTv and its NFL contract), Netflix has enjoyed low cost programming.

Netflix may have a few more great quarters, or even another 2 years...but I can't view a world where Netflix maintains its dominant market share.

Here's a good article supporting


Anonymous said...

David said...

Well done.