Besides the fight for dominance in the mobile industry, there is another battle out there for victory in the industry of internet video on demand (VOD) services. Some big players now are Netflix (NFLX), HuluPlus and Amazon (AMZN) prime. Who will be standing at the end of this rumble?
For a while now, one outstanding characteristic that Apple and the Google (GOOG) Android phones had that other smartphones didn't was the high library and availability of apps, or applications that users could install to facilitate day-to-day activities. In the world of VOD, where users have the leisure and freedom to select what they want to watch and when they want to watch it, the distinguishing factor that will separate the successful VOD companies will be the ability to be exclusive.
Netflix, HuluPlus and Amazon Prime, and even Comcast (CMCSA) charge customers a premium every month in order to watch movies, documentaries and television programming on demand. Rational consumers will behave according to cost-benefit ratios, and if a consumer thinks the benefit of having membership in one of these VOD services is worth the price paid every month, then the consumer will sign up for the service. In my opinion, a consumer will most likely spend extra dollars on one of these services if the membership will provide access to programs or videos that the consumer cannot find anywhere else, or the exclusivity of certain programs for a single VOD provider. The provider that wins the battle for exclusivity wins the war.
Currently, all of the VOD providers have exclusive rights to certain programs. Amazon Prime exclusively shows "Downton Abbey" and "Falling Skies," HuluPlus has rights to "Community" and "Battleground," and Netflix has the original "House of Cards" and "Arrested Development." The costs to acquire the licenses and rights for these programs are getting more and more expensive as entertainment companies are taking advantage of the increased competition among VOD providers. Furthermore, it is becoming increasingly difficult to ensure that a company is the sole proprietor of a program unless it is an original. Despite these challenges and increasing competition from other industries such as cable on demand and DVR, there is an obvious leader in the VOD industry.
On February 1, 2013, Netflix premiered its first original series "House of Cards," a political drama that has been "very successful" according to CEO Reed Hastings. When asked about the ratings for the new series, Chief creative officer Ted Sarandos stated,
"I honestly have no motivation to do it. I don't sell ads, so ratings don't matter in that way."
Agreeing with Sarandos, I do not think the ratings of the show are crucial because it is not the success of this series alone that will make or break Netflix as there have been plenty of successful original series such as "Battleground" from Hulu. Netflix has a subscriber-first attitude that invests in its members' loyalties, and it is this business philosophy that will keep it competitive in the long run. A big question was why Netflix released the entire series all at once, and to answer that curiosity, Hastings expressed that this method was more analogous to "reading a book" as viewers now had access to all the chapters just like a book. Also, because many Netflix subscribers have the time and desire to watch multiple episodes, the entire season release allows the customers to satiate those desires, eliminating the frustration of the traditional wait.
Another advantage of Netflix's original programming is that it does not have to confine to the strict 56 minutes of program as the series was designed for on demand streaming without commercial interruptions. This freedom allows developers and producers to create higher-quality products by making the endings of each episode appear more natural. Lastly, Hastings has mentioned that "House of Cards" will be exclusive for Netflix for at least the next few seasons, generating a reason for people to continue a subscription.
Also, in May 2013, Netflix will premier season four of its original series "Arrested Development" after Fox discontinued the series in 2006. Then in April, Netflix will release an original Eli Roth horror thriller after the political drama. Adding the original series and the thriller gives Netflix additional exclusivity as well as diversity in its programming. Diversity is important for operations because this gives Netflix leverage in negotiating contracts with entertainment companies as well as catering to a broader range of consumers. HuluPlus and Amazon Prime do not provide access to the extensive array of cartoons, anime, documentaries and eclectic material that appeals to certain audiences around the world.
Additionally, Netflix is quickly expanding its service globally to South America, the Caribbean, United Kingdom, Ireland, Sweden, Denmark, Norway, and Finland. As for its competitors, HuluPlus content can only be streamed in the United States and Japan, and Amazon Prime can only be streamed within the United States. Currently, Netflix has 23.6 million users in the United States and 27 million users outside of the United States with 10 million new international subscribers this coming year. With each additional member equating to $7.99/month, Netflix can guarantee substantial revenue from international exclusivity.
Currently, Netflix is trading at a P/E of 619 and a PEG of 30.9 with a (92.9%) one-year growth rate. From a raw financial perspective, those numbers show a heavily over-bought company that cannot keep up with the investor sentiment. I would agree that Netflix is over-bought right now, but I am also confident that higher earnings will come in the future as more new members subscribe in coming quarters with the allure of novel original programming, a recent deal with Time Warner (TWX), and the activation of the Disney (DIS) contract in 2016. Furthermore, in the coming years, international subscriptions will increase dramatically with continuous expansion into other countries, bringing in additional subscription fees. Lastly, for the past seven quarterly earnings reports, Netflix has reported positive surprises indicating that consumers are jumping to subscribe to Netflix VOD faster than expected. Netflix may appear to be a house of cards, but the foundations are actually sturdier than you think.
Currently, Netflix is sprinting ahead in share value, but soon NFLX will face a market correction as P/E is absurdly high. Once shares drop to around the $150 range, it would be a reasonable time to initiate a long position because there is no doubt that Netflix is the winner in this bout over VOD dominance.