On several occasions I prefer to look at a company's valuation from a pure 'Replacibility' or 'Replicability' within its industry. Replacibility being its susceptibility of being replaced by a new entrant and Replicability being it susceptibility of being copied. One company that has often fallen on the list for this analysis methodology is Netflix (NASDAQ:NFLX) - more because of the industry that it belongs to: Media Delivery. This industry is ultimately about getting the acquired content to the end consumer and Netflix had been the David of the market when Blockbuster was the Goliath. Back in 2005, a small company was able to replace a larger Blockbuster due to the delivery model that it brought with it. However, I now find Netflix to have grown so much in its valuation that it is the new Goliath of the Media delivery playing field.
In my mind, this industry is about three fundamental things:
1. Content acquisition
2. Infrastructure to deliver the content
3. Consumers willing to pay for it
With that in mind let us take an approach of valuing Netflix based on 'Replacing' it from the market by 'Replicating' a new Netflix. Let's call this new company neoNet.
1. Content acquisition - the value of Netflix's Current and Non-Current Content Library is ~$2.5 billion. Assuming that we were to acquire the same content on our own - it would potentially cost us about the same. But for arguments sake let us say we pay a premium of 20% over what Netflix has paid. This high enough premium (surely for non-current content) would cost neoNet $3.0 billion.
2. The Infrastructure needed would include people, facilities and technology and should not cost more than $1.5 billion if we have the content. Over the last 4 years, Netflix's Technology and Development spend has been ~$900M and SG&A has been ~$400M. Their PPE is currently valued at $130M.
3. Lastly, the most important aspect is acquiring the consumer. For that let us consider the 30 million customers with Netflix. On an average Netflix has acquired them based on a 1 month free subscription. Given that we have replicated the content and the infrastructure, we should be indistinguishable in the eyes of the consumer. Many would argue on Netflix being a brand, but that is not true. It is just the content and the delivery that matters in this industry. No body swears by Netflix or has a NFLX tattoo on their arm. People do that for Harley Davidson not for Netflix. This leads to the price of stickiness or switching cost. I am hoping that if we are able to pay $50 to each of these consumer (equivalent of roughly 6 month subscription) we should be able to acquire all of them from Netflix and make them customers of neoNet. This would be at a cost of $1.5 billion ($50 times 30 million users)
Once this has been accomplished it would mean the end of Netflix and the beginning of neoNet, because every existing customer would have switched over to neoNet and every new entrant would rather try neoNet for 6 months than try Netflix for 1 month. A price war could potentially start leading to the destruction of both - meaning that the peak value of neoNet is achieved at the start. Therefore with that analysis, at a very high end the valuation of neoNet being the replica is $6.0 billion ($3.0b for content, $1.5b for infrastructure and $1.5b for consumer acquisition). For safety sake let us add another $1 billion in unexpected execution cost and $0.5 billion in my paycheck for this idea - leading to a valuation of $7.5 billion. This still leaves a gap of $6 billion (>40%) from the current valuation of Netflix of $13.5 billion (stock price of $240), which is why I am unable to fathom a price of greater than $200 on this stock.
Disclosure: I am short NFLX and have a put option on it. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have a put option on NFLX