I have viewed Netflix (NFLX) in much the same way that I have viewed Amazon.com (AMZN) - a company that provides a rather invaluable service to its customers, but has a business model that may not be successful in ever really generating the bottom-line numbers that investors expect. While I still believe the valuation is a bit rich on Netflix, I do think that the company's attempts to provide original, exclusive content for its viewers is integral to the long-term viability of the company, and I would like to see more aggressiveness here going forward.
Arrested Development: An Example
I am a very happy Netflix subscriber (and I even pay extra for the 4-simultaneous-streams package), so you can imagine my delight when I learned that one of my favorite TV shows of all time - Arrested Development - would be seeing an exclusive comeback on Netflix in a fourth season.
When the shows came out just a few days ago, I watched the entire season in a row. I personally enjoyed the season quite a bit, but I could see precisely why the reviews were pretty mixed: it felt just a little bit lacking in content.
See, Arrested Development's "claim to fame" so to speak was that it followed each character in the Bluth family simultaneously, making for a rather exciting and varied show. Each episode would build off of what had come before it, but at the same time new characters, ideas, plots and sub-plots were introduced as time marched on.
The fourth season was a little bit different. Rather than be 15 episodes in the traditional, each of which another part of a story line that progressed, the show instead opted to essentially paint one very large story and then show different slices/angles of the story in each of the 15 episodes. It was superbly well done, but it was certainly not enough. As a viewer, you could tell that the scope that would come with a traditional "season" of the show just wasn't there. This was a very, very well done multiple-angle view of the world of Arrested Development, but calling it a "season" in the traditional TV sense may be pushing it quite a bit.
It is nice for Netflix that this is Netflix-exclusive content, and I believe that over time, the library of original content becomes vastly richer, but if I were to invest in the name, I would absolutely need to see a deeper commitment to the various "original" shows. Carrying on the Arrested Development example, what would I want to see as an investor?
What Would I Like To See?
Here's what I would like to see from the original content going forward from an investment perspective:
- Targeted, High Quality Content: Let's face it - most TV is crap. I spent the entirety of my college career without a TV and I didn't miss it one bit. All of the "good", perhaps older stuff was available either through Netflix or through various sites such as "Hulu". Netflix's choice to bring back a cult favorite with "Arrested Development" was certainly a representative sample, and I am hoping that the company could feature originals based upon more "cult-classic" IP in order to bring in and retain the viewership. Building a permanent library of exclusive content is great for this sort of subscription style service. These types of shows should be "brought back" across multiple genres targeting multiple types of viewing tastes
- More Of The Good Stuff: The company can't do "one off" shows, however. There needs to be follow-through and regularity of the content that subscribers want most. For instance, I would much prefer weekly episodes of, say, an "Arrested Development Season 5" that were more like the originals rather than a one-time payload of "one story told through multiple perspectives". It is tougher to get subscribers to actually keep their subscriptions if they've "seen it all"
In short, Netflix has a golden opportunity to be more than just a BlockBuster-over-the-Internet, and these original content plays are the first step to really getting to that level.
Netflix As An Investment?
My readers know that I abhor a bubble, but I would not be particularly keen to take a long-term short position on this name. The potential for the company, especially as it moves to original content, is quite high.
Right now, Netflix trades at 545x trailing twelve month earnings, but analysts expect some serious velocity on the EPS growth front, with FY2014E estimates at $3.40, implying a forward P/E of 65. This is still rather rich, but a few years of hyper growth along this trajectory means that the company could very easily grow into that multiple, and perhaps even double yet again from here in a year or two.
But whether to buy or not really depends on whether these analyst estimates are a result of too much Kool-Aid drinking or if they are legitimate. If Netflix hits its 2014E analyst EPS target of $3.40, then sure, shares could continue to rally. But if something goes wrong ("cost of content" is a big bearish argument), then the market will substantially reprice the shares to the downside.
I wouldn't be a buyer here as there is too much risk for my own portfolio, but if you really believe the Netflix story, then I would wait for a broad market correction or even just a pullback and then buy.
Netflix is a good company doing some interesting things with its platform, and I think there's plenty of potential there. Whether the market has priced in said potential or not, and whether it is a good buy after this run up, remains to be seen. I would stay on the side-lines for now, and if you want to buy, I'd wait for a significant pullback.